The minutes of the latest MPC meeting that were made public on Friday, August 20 is likely to be a landmark of sorts: it may well be remembered as the Jayant Varma minutes or more likely as the one that has definitely made a turn towards normalising the highly accommodative monetary policy that has been in vogue since COVID-19 struck in March 2020.

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Dr Varma’s arguments are persuasive.

1. COVID-19 is like tuberculosis, it’s killing people not the economy so much. Monetary policy is not meant to mitigate human tragedies but economic crises. Also, for now, the pandemic looks like it may well drag for 3-5 years, says Varma, pointing to the new wave in much-vaccinated Israel. So, while an ultra-accommodative policy can be justified to weather the initial shock, can it be justified for 18 months? 2 years? is the question he puts on our plate.

2. Secondly he points out that monetary policy impacts the entire economy uniformly, but COVID-19 has hit some sectors (like hospitality) and some areas ( like Kerala ) and some segments (like MSMEs and the weaker sections) more than others. Sector-wise help can only be provided by fiscal policy.

3. Thirdly, he says monetary accommodation may in fact be creating a problem by stimulating asset price inflation, something Mridul Saggar also hints at when he flags the danger of markets getting “opiated to slush liquidity, designed as a temporary crisis measure...”

4. Fourthly, Varma says inflationary expectations may be already getting entrenched. He fears there is less confidence now that demand-side pressures will remain muted. Indeed in a way, even Ashima Goyal, Mridul Saggar and Michael Patra flag the likelihood of inflation, and Patra call it the price that one has to pay for growth. Varma points out that even in the first quarter of FY23 inflation is not expected to fall below 5 percent revealing a persistent element in the price rise. The satisfaction that it is below 6 percent is not enough, since the mandate is for 4 percent.

Varma is emphatic that the reverse repo rate of 3.35 percent is inappropriate and needs to be raised and brought closer to the repo rate of 4 percent. Even at 4 percent, savers suffer a negative real return of 1-1.5 percent; but at 3.35 percent the negative real return rises to 2-2.5 percent which is wholly unjustified, according to him.

While it is true that neither reverse repo rate nor liquidity is the remit of the MPC, such a strong push back from Varma cant be ignored by the MPC or the markets. It is very likely, therefore, that short term yields will start rising from here on, in anticipation that the best of accommodation is behind us and the RBI, if anything, will advance its normalization timetable after the August MPC.

The fact that normalization may start sometime soon, gets tacit support from Ashima Goyal and Mridul Saggar too. “Gradual adjustments are possible within the accommodative stance”, says Saggar, while Goyal says “other normalization can start even in accommodative stance”, a noteworthy statement coming as it does from one of the most dovish members.

It is clear therefore that the contours of the debate have shifted from whether normalization should start this year to when it should start. The questions from now on are : Will RBI remove liquidity first and then hike reverse repo? Can reverse repo be hiked even with current liquidity? Can reverse repo be hiked even with an accommodative stance?

Separately, all this should delight equity markets. Just as for global equity markets the talk of taper is actually good news since it acknowledges growth, likewise rise in overnight yields should in fact spur equity markets, since it shows the economy is normalizing,

First Published:Aug 22, 2021 7:26 PM IST