Informist, Monday, Apr 22, 2024

--MPC Goyal: Can wait to see impact of possible future supply shocks

--MPC Goyal:Don't need real rate above neutral if core CPI is below 4%

--MPC Goyal: Don't need real rate above neutral if CPI is near target

--CONTEXT: External MPC member Ashima Goyal's remarks in an interview

--MPC Goyal:Can keep real rate neutral for growth to reach potential

--Goyal: Listed reasons for a cut in MPC minutes to encourage debate

By Shubham Rana

NEW DELHI – In an environment of uncertainties, the Monetary Policy Committee can afford to wait and watch for the potential impact of supply shocks on the glide path of headline inflation to the target of 4%, even if the real interest rate remains high, says Ashima Goyal, external member of the Reserve Bank of India's rate setting panel.

"In the fragile global environment, domestic flux as the nation votes, uncertainties about the progress of the monsoon, we can wait for some time to watch the impact of possible future supply shocks on the stability of core inflation and convergence of headline to the inflation target," Goyal tells Informist in an email interview after the RBI on Friday released minutes of the Monetary Policy Committee's Apr 3-5 meeting.

At its first meeting of 2024-25 (Apr-Mar), the six-member MPC decided to keep the repo rate unchanged at 6.50% and maintain the 'withdrawal of accommodation' policy stance.

Even as Goyal voted to keep the repo rate and policy stance unchanged, she made several arguments in favour of lowering the repo rate.

The minutes showed that Goyal said real interest rates were currently higher than the neutral rate of interest – the rate which is compatible with keeping inflation at target and output at potential. Goyal had also said that even with a cut in the repo rate, policy would still be contractionary. In the past, she has said that a real rate of around 1% is the optimal rate to bring inflation to the 4% target without hurting growth.

Goyal made these arguments only to "encourage debate and discussion", she tells Informist.

Real interest rate is defined as the rate of return over and above the rate of inflation in an economy. The RBI has projected CPI inflation for 2024-25 at 4.5%. If the repo rate stays at 6.5% for the full year, the real rate of interest would be 2.0%. Currently, headline inflation is at 4.85% and with the repo rate at 6.50%, the real rate of interest is 1.65%.

For months, Goyal has argued that the real interest rate is too high, a stance she still maintains.

"In India, if core inflation is below 4% and headline is durably approaching the target, there is no need to keep real policy rates above the neutral level, especially if the supply-side action and anchored inflation expectations of firms that have brought inflation down in the past continue," says Goyal, also a professor at the Indira Gandhi Institute of Development Research. "There is scope, instead, to keep real policy rates at neutral to allow growth to reach potential."

There is no official measure of what is the optimal neutral rate of interest. According to an RBI staff paper published in June 2022, the neutral rate of interest in India was 0.8-1% during Oct-Dec 2021, lower than 1.6–1.8% estimated earlier for Jan-Mar 2015. A rate of interest that is neither expansionary nor contractionary for the economy is called the neutral rate of interest.

But the high real policy rate is not a worry right now because of robust GDP growth, high profitability of corporates, and high credit growth, says Goyal. Instead, with multiple uncertainties, stability remains the MPC's priority, she says.

Following are edited excerpts from the interview:

Q. We have seen consistent supply-side shocks and geopolitical tensions for several years in a row. Supply-side shocks cannot be controlled by monetary policy. In such a scenario, how long can the MPC afford to wait and watch before high interest rates impinge on growth?

A. While the MPC cannot control supply shocks, its actions such as ensuring repo rates responded to persistent inflation above the tolerance band, credibly anchored inflation expectations and contributed to keeping inflation within the tolerance band despite severe price shocks. And this was done along with a robust growth recovery.

Q. RBI Deputy Governor Michael Patra has said that the real interest rate should be assessed in terms of the distance at which inflation is from the target. Do you share this view?

A. It is the standard policy for central banks to keep real policy rates above neutral, in a restrictive stance, if inflation is above their target. The neutral real policy rate is that which keeps inflation at target and output at potential. But in India, if core inflation is below 4% and headline is durably approaching the target, there is no need to keep real policy rates above the neutral level, especially if the supply-side action and anchored inflation expectations of firms that have brought inflation down in the past continue. There is scope, instead, to keep real policy rates at neutral to allow growth to reach potential.

Q. Your comments indicate you are more inclined towards voting for a rate cut rather than status quo. Why do you continue to vote for a pause?

A. I have clearly written that multiple current uncertainties make stability the priority for the MPC. So, in my view, status quo was required for the April policy.

I listed arguments for a cut in the minutes to encourage debate and discussion. Standard estimations, which neglect issues important for emerging markets, raise the neutral rate with growth. But allowing for higher catch-up potential growth lowers it. You know that the market view and that of almost all analysts is for a pause until the Fed starts cutting. But post the pandemic, Indian policy has demonstrated that it has the space to respond to the domestic cycle rather than follow the US cycle and doing so has helped the economy do well. Maximum debt inflows came in when interest differentials with the US were the narrowest. Our analysts should consider these issues.

Q. You're nearing the end of your tenure on the MPC. Would you want to maintain status quo and stability in monetary policy before handing over to the new members?

A. I would want to make my recommendation based on how incoming data affects inflation, growth, the neutral rate, and future expectations.

Q. Considering inflation is already converging towards target, do we still need the current real rate of 2%, which is a disinflationary rate?

A. At current real rates, growth is robust, firms' profitability is high, and credit growth is also high. Therefore, in the fragile global environment, domestic flux as the nation votes, uncertainties about the progress of the monsoon, we can wait for some time to watch the impact of possible future supply shocks on the stability of core inflation and convergence of headline to the inflation target. End

Edited by Avishek Dutta

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