MPC meeting. Real repo rate of around unity suits the current stage of the cycle: RBI MPC member Goyal

A real repo rate of around unity suits the current stage of the cycle as it balances the conflicting requirements of inflation and growth, savers and borrowers well, according to Monetary Policy Committee (MPC) external member Ashima Goyal.

“The real rate is already positive and is likely to become more so, if inflation falls. The RBI’s average inflation forecast for FY 24 of 5.3 per cent gives a real interest rate of almost unity with a repo rate of 6.25 per cent.

“It can rise above this if inflation comes in below expectations that are based on an oil price of $95, risking a procyclical stance as policy tightens despite pressures on growth,” opined Goyal at the MPC meeting held on February 6-8.

Policy would then have moved away from the nuanced countercyclical stance that has been very effective in smoothing recent external pluri-shocks, she said adding, market inflation expectations are below those of the RBI.

The MPC hiked the policy repo rate by 25 basis points from 6.25 per cent to 6.50 per cent by a majority of 4-2.

Goyal, who is Emeritus Professor at Indira Gandhi Institute of Development Research, Mumbai, and Jayanth R Varma, Professor, Indian Institute of Management, Ahmedabad, voted against the two resolutions—increase the policy repo rate by 25 basis points to 6.50 per cent with immediate effect; and remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.

Goyal observed that a real repo rate of around unity ensures nominal rates rise with expected inflation as is required in inflation targeting but prevents large nominal volatility.

“Research shows that it is better to limit volatility so that real interest and exchange rates, which impact the real sector, do not deviate much from their equilibrium values. Some volatility of nominal rates is good for financial stability, as long as volatility is limited,” she said.

Goyal emphasised that if a sharp rise in the real policy rate, substantially above unity, triggers a shift to a lower trend of private investment and growth, then the sacrifice ratio of disinflation can be very high, as it was in the 2010s.

“When such multiple paths exist, over-tightening today does not necessarily improve the future. Inflation can rise over time because supply bottlenecks worsen,” she said.

Excise tax cuts

Goyal observed that it may be time for some more excise tax cuts as multiple supply shocks have imparted persistence to inflation.

She emphasised that the large commodity component in India’s consumer price basket and pockets of supply constraints respond better to fiscal action.

“Our government has used such action very effectively in the pandemic period. Inflation still has many administered price components and all regulators need to internalise the inflation target in order for it to be achieved.

“If inflation remains within its tolerance band, the MPC can keep real interest rates low so that growth remains high and contributes to reducing the government debt/GDP ratio,” she said.

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