Prof Jayanth R Varma, one of the six members of the Reserve Bank of India's (RBI) monetary policy committee, has suggested taking a hard look at the accommodative stance.
The current stance of the monetary policy is accommodative, which means keeping the system liquidity at surplus mode for supporting the recovery in the economy. "As the pandemic continues to mutate, it appears to me the balance of risk and reward is gradually shifting, and this merits a hard look at the accommodative stance," suggested Varma.
Varma is suggesting a 'neutral' stance, which means keeping the system at a slight liquidity surplus position, but the interest rates could move upwards.
Varma's comments are a part of the minutes of the MPC meeting that took place in the first week of August.
"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," said Varma.
He said the monetary policy is much less effective than fiscal policy for providing targeted relief to the worst affected segments of the economy. "Indeed, monetary accommodation appears to be stimulating asset price inflation to a greater extent than it is mitigating the distress in the economy," says Varma.
Varma also observed the inflationary pressures are beginning to show signs of greater persistence than anticipated earlier. There are indications that inflationary expectations may be becoming more widely entrenched. "Most worrying of all, there is now a reduced degree of confidence that demand-side inflationary pressures would remain quiescent," said Varma.
The inflation, after averaging above per cent in 2020-21, is forecast to be around 5.7 per cent in 2021-22.
"While there is some comfort that inflation is forecast to be below the upper end of the tolerance band, it is important to emphasise the inflation target for the MPC is 4 per cent and not per cent or even 5 per cent," he said.
"The tolerance band is designed to allow for forecast errors, implementation shortfalls and measurement issues. Treating 5 per cent as the target would significantly increase the risk of inflation targeting failures," he said.
Varma also said he has been for some time arguing that if the reverse repo rate does not fall within the remit of the MPC, the announcement of this rate should be in the Governor's statement and not in the MPC's statement, but this view has not found favour with the rest of the MPC.
"Hence, I have no choice but to express my disagreement with the level of the reverse repo rate. A gradual normalisation of the width of the corridor is warranted. In my view, a phased normalisation of the corridor would increase the ability of the MPC to keep the repo rate at 4 per cent 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," he said.
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