Need to keep real rates at level to sustain virtuous cycle: Ashima Goyal

Ashima Goyal tells Manojit Saha in an email interview that the inflation rate does not necessarily have to fall to 4%, but it is essential to be confident that it will stay below 5%

Ashima Goyal, an external member of the RBI’s monetary policy committee, tells Manojit Saha in an email interview that the inflation rate does not necessarily have to fall to 4 per cent, but it is essential to be confident that it will stay below 5 per cent in a sustainable manner and approach 4 per cent so that cutting rates can be considered. Edited excerpts:

While you have noted growth exceeding expectations, you also pointed out areas of weakness -- in consumption, income tax, and merchandise exports. You have mentioned employment offers have slowed in Indian Institutes of Technology. Is there a concern that real rates, if they remain high for too long, could start hurting economic growth?
 

Yes. With India’s young population able to borrow based on their salaries, the interest elasticity of demand is high. Demand for consumer durables and housing, and equipping new houses, stimulates investment in many industries. Investment creates capacity and reduces inflation. Income, employment, and savings rise. We aim to maintain real interest rates at a level that sustains this virtuous cycle without creating excess demand-led inflation. In my view, at present, that rate is around 1 per cent. Real rates above that have adversely impacted Indian investment cycles in the past decade.
 

There is a view that the output gap has turned positive. What is your take on this issue?
 

Estimating potential output accurately is challenging. Time series methods give undue weight to past output and fail to capture structural changes that may have raised potential output. As reforms reduce the cost of doing business, infrastructural bottlenecks are eased, skill acquisition occurs, and potential growth rises. We have not yet achieved the potential growth required to offer productive employment to our young labour force entrants. So, I favour forward-looking estimates of the output gap based on inflation. The gap cannot be positive, creating excess demand in the economy if the core inflation rate is around 4 per cent and falling. There is no generalised overheating.
 

You have said, citing the example of 2018, “if inflation sustainably approaches 4 per cent by the middle of 2024, real rates can easily become too high if nothing is done”. Do you think the repo rate can be lowered even if the headline inflation rate does not fall exactly to 4 per cent but a high real rate is a sufficient condition for beginning to cut rates?
 

There had been instances when inflation forecasts were nearing 4 per cent, but the actual inflation rate rose due to supply shocks. The rate does not have to fall to 4 per cent, but we need confidence that it will sustainably stay below 5 per cent and approach 4 per cent to consider rate cuts. The US Federal Reserve’s projections show three rate cuts next year, even though they have not yet reached their inflation target. As inflation and projections fall, their real policy rates would otherwise be too high. Even with rate cuts, monetary policy remains disinflationary if real interest rates are high. So, even with expected rate cuts, their focus remains on reaching their inflation target.
 

When do you see the first reduction in the repo rate?
 

I would like to see a reduction if the expected real repo rates are sustaining above 2 per cent.
 

Under what conditions can the stance of the policy be changed to “neutral”?
 

A policy stance provides forward guidance. It is difficult to give such guidance in these uncertain times. Most central banks are now data-dependent. Markets also need to assess incoming data to anticipate policy actions. In the past, a neutral stance indicated that all kinds of rate actions were possible. Therefore, the conditions that allow the stance to be changed to “neutral” are the same as those that make a rate cut possible. However, rather than the current “withdrawal” or the past “neutral”, a “disinflationary” stance that allows for rate cuts but remains focused on reaching the inflation target may convey a more appropriate signal.