Your term at the MPC has seen an unprecedented combination of shocks. How did the structures of monetary policymaking hold up to these challenges and can there be improvements?
Inflation targeting has delivered even in a period of multiple adverse shocks. Since inflation fell despite recurrent supply shocks with a real repo rate around unity, it is clear that a high real repo is not required for the credibility of inflation targeting. It is sufficient if the policy rate rises with persistent inflation – indicating there will be action against it. These lessons should be internalised.
Headline (inflation) should remain the target since it affects the public, but the MPC should pay more attention to core inflation. Forecasts of core inflation should be made public. Research shows that in India, causality is from core to headline, and in the longer term, core has the largest impact on household inflation expectations. So being explicit about these interactions would help anchor expectations and increase understanding of the inflation process. Even trend food inflation guided by MSP changes should not be higher than the target. At present, there is too much focus on individual volatile commodity prices. Formalising government responsibility to reduce price spikes may induce better productivity-enhancing and market-developing interventions.
The MPC should also give guidance on liquidity, like in advanced economies so that the operating target does not differ for long from the repo rate it sets.
You mentioned in the latest MPC minutes that average Indian inflation is lower and trending down. What has brought this about?
We have had an inflation target of 4% for a decade now, and inflation has been lower than its historical values during this period. Lower expected values of inflation must be slowly getting internalised in all kinds of pricing and wage settings in the economy. Also, as the economy grows in scale and diversity, relative price shocks have less of an impact on aggregate prices. The government is also acting more aggressively against supply shocks. Non-inflationary growth in India requires effective supply-side action.
You have highlighted the importance of shifting from interventions that distort resource allocations to those that boost agricultural productivity.
We all know how free electricity and MSPs for select cereal crops have distorted resource allocation in Punjab. India’s food security system is expensive and becoming outdated as cereals no longer dominate food baskets. To prevent the recent kind of spikes in vegetable prices requires use of agritech, diversification in agricultural production and in supply chains. Food supply has to be made resistant to climate shocks.You have alluded to social and political instability, depending on how different social groups are affected by interest rates. Do you feel there is a need for monetary policy to be more flexible?
Yes, the social contract that has delivered in the post-pandemic period is for the MPC to hold the real repo rate at the minimum level that anchors inflation expectations, even as the government acts to lower inflation from the supply side. This allows growth to rise to the highest possible non-inflationary level and more to participate in economic development. Without such inclusive growth, the redistributive agendas that held India back for so long will resurface and hurt its development prospects.