Jayanth Varma: Why Jayanth Varma voted against RBI’s accommodative policy stance

The minutes of the MPC released today shed light on the reasons behind his decision. Prof Varma said that the “balance of risk and reward is gradually shifting, and this merits a hard look at the accommodative stance”.

The RBI kept the repo rate unchanged at 4 per cent in its meeting held in August and kept the growth forecast intact at 9.5%.

The RBI raised its inflation projection for the entire year to 5.7% from 5.1% earlier. However, it continued to describe the spike as transitory. Prof Varma’s dissenting MPC position appears to have factored in the long term implications of keeping the monetary stance accommodative.

“Monetary accommodation appears to be stimulating asset price inflation to a greater extent than it is mitigating the distress in the economy,” Prof Varma said.

As the Covid cases pick up in rest of the world including some of the countries like Israel with higher vaccination rates, Prof Varma said that the pandemic could be with us for 3-5 years with reduced mortality.

In such a context, keeping the stance accommodative for a long horizon merits a review.

“The possibility that Covid-19 will haunt us (though with lower mortality) for the next 3-5 years can no longer be ruled out. 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 expressed disagreement with the decision to keep the reverse repo unchanged and argued that the normalisation of the LAF corridor will allow the focus to remain on keeping the main policy lever, the repo, at 4% for longer period.

“I have no choice but to express my disagreement with the level of the reverse repo rate. A gradual normalization of the width of the corridor is warranted. In my view, a phased normalization of the corridor would increase the ability of the MPC to keep the repo rate at 4% for a longer period, and this should in my view be a greater priority for the MPC than maintaining an ultra-low reverse repo rate for some more time,” Varma noted.

A hike in reverse repo will allow the RBI to suck more liquidity from the system and keep inflationary pressures in check.

Prof Varma’s comments on reverse repo came in the light of inflationary projection that for the current fiscal is expected to remain above the 5% level. Prof Varma said that it is important to remember that inflation target for the RBI is 4% and not 6% or even 5%.

“The tolerance band is designed to allow for forecast errors, implementation shortfalls and measurement issues. Treating 5% as the target would significantly increase the risk of inflation targeting failures,” Varma said.