Professor Varma was the only detractor among the six members of the Reserve Bank of India’s rate-setting panel and marked the first sign of fissure in the panel on monetary policy since the beginning of the pandemic.
The rate-setting panel at its August meeting had kept the repo rate unchanged at 4 per cent and stuck with its “accommodative” stance on monetary policy until durable growth was visible in the economy. The MPC had also raised its forecast for inflation in the coming quarters and suggested that inflation in 2021-22 will be at 5.7 per cent, which is just shy of the top-end of its inflation target band of 2-6 per cent.
“I fear that the forward guidance and monetary stance are becoming counterproductive. By creating the erroneous perception that the MPC is no longer concerned about inflation and is focused exclusively on growth, the MPC may be inadvertently aggravating the risk that inflationary expectations will be disanchored,” Varma said in the minutes of the meeting released today.
Varma argued that the rate-setting panel was at risk of pushing risk premia higher and thereby long-term rates by focusing too much energy in keeping short-term rates low whereas keeping long-term rates low should be the priority to enable investment-led growth.
“Easy money today could lead to high-interest rates tomorrow,” Varma said, arguing that the MPC should demonstrate its commitment to the inflation target with “tangible action” to anchor inflation expectations, reduce risk premia and sustain lower long-term rates.
“While there is some comfort that inflation is forecast to be below the upper end of the tolerance band, it is important to emphasize that the inflation target for the MPC is 4 per cent and not 6 per cent or even 5 per cent,” Varma said.
Varma argued that the central bank should consider raising the reverse repo rate that is currently at 3.35 per cent, as a shorter monetary policy corridor will increase the ability of the MPC to keep repo rate at 4 per cent for a longer period.
In a scathing remark, Varma also argued that the central bank’s accommodative stance was stimulating asset price inflation to a great extent rather than mitigating distress in the economy. Varma suggested that the recent experience globally with the Delta variant in highly vaccinated countries has shown that the pandemic will “haunt us for the next 3-5 years”.
“Keeping monetary policy highly accommodative for such a long horizon is very different from doing so for what was earlier expected to be a relatively short crisis,” Varma said.
