The Reserve Bank of India’s Monetary Policy Committee repeated the Union Budget’s optimistic forecast about the economy’s growth prospects in 2021-22, reiterated the need for continued policy support, and was sanguine about the inflationary outlook — all messages that highlight the Indian economy’s sharp recovery from the impact of the ongoing (but slowing) Covid-19 pandemic.
In sync with the Budget’s assessment of the economy going forward, MPC has projected a gross domestic product (GDP) growth rate of 10.5% in the fiscal year 2021-22. MPC’s decision to keep interest rates unchanged while retaining an accommodative policy stance also suggests that while having passed the baton of economic revival to fiscal policy from interest rates, the central bank will continue to support this process by maintaining liquidity.
Over the past year, MPC cut the policy rate by 115 basis points — one basis point is one hundredth of a percentage point — from February 2020 to 4% it is at now, and infused a total liquidity of ₹9.37 lakh crore (since March 2020) into an economy roiled by Covid-19 and the lockdown imposed to slow its spread. To be sure, the net excess liquidity in the system, captured by banks parking their excess cash with the RBI, could be ₹6.5-7 lakh crore. The economy contracted by 24% in the three months ended June 30 and 7.5% in the three months ended September 30, but has recovered since, with many high-frequency indicators in the green.
“While the year 2020 tested our capabilities and endurance, 2021 is setting the stage for a new economic era in the course of our history,” RBI governor Shaktikanta Das said in his press conference after the MPC meeting. “I would like to say that, going forward, the Indian economy is poised to move in only one direction and that is upwards,” Das said while concluding his statement.
While the formal sector of the economy seems to be on a strong recovery path, consumer sentiment, as seen in RBI’s Consumer Confidence Survey (CCS), has not shown a concomitant recovery, although it has shown sequential improvement over the past two rounds conducted in November 2020 and January 2021. The latter is likely to be a result of continuing weakness in labour markets and the informal sector. The inference is that MPC may fear that the ongoing economic recovery might be jeopardised by a sudden withdrawal of accommodative monetary policy.
In its first meeting after the 2021-22 Budget, MPC projected a GDP growth of 10.5%, 50 basis points less than the 11% forecast by this year’s Economic Survey. The 2021-22 Budget has projected a nominal GDP growth of 14.4%, one percentage point lower than what the Economic Survey had projected. MPC has kept the policy rate unchanged at 4% and monetary policy stance has been kept accommodative, which is in keeping with the forecast by a Reuters poll of economists.
The MPC’s resolution expects rural demand to remain resilient and a recovery in urban demand with fall in Covid-19 cases and spread of vaccination. This indicates a more sober approach vis-a-vis the state of the economy unlike what is presented by high frequency indicators such as the Purchasing Managers’ Indices (PMI) which have been showing a strong growth revival in the past few months. Both PMI manufacturing and services have been higher than the critical threshold of 50, which signifies an expansion in economic activity over previous month, since October 2020.
Results from the latest CCS round, which was conducted in 13 major cities in the first two weeks of January, support this cautionary view. While consumer confidence has seen a recovery from the values immediately after the lockdown, it continues to be significantly lower than pre-pandemic levels. For example, the Current Situation Index from the CCS was 55.5 in January 2021, which although higher than the all-time low of 49.9 in September 2020 was significantly below the March 2020 value of 85.6. Net current perception on employment in January 2021 was -62.3% as against -30.5% in March 2020. This number had fallen to -71.6% in the September 2020 round. Net perception is the difference between the shares of respondents who reported an improvement and worsening compared to last year.
To be sure, the RBI’s Industrial Outlook Survey in the October-December 2020 period shows a sharp recovery in current and future expectations of production in the third and fourth quarter of the current fiscal year, which suggests a sentiment mismatch between consumers and producers.
The benchmark inflation rate, as measured by the Consumer Price Index (CPI), came down to 4.6% in December 2020, the latest period for which data is available, after having stayed above the upper limit of RBI’s target range of four plus minus two percent since April 2020.
MPC’s outlook on inflation has turned benign in the short run (5.2% in the January-March 2021 quarter instead of an earlier projection of 5.8%) thanks to a moderation in food prices on the back on higher supplies of vegetables and kharif crops and a weakness in poultry demand because of the bird flu outbreak. However, the MPC has made an upward revision in its inflation forecast for inflation in the April-September 2021 period to 5.1% from an earlier forecast of 4.9%.
It is non-food items which are seen as the source of inflationary going up in the first half of the next fiscal year. The MPC resolution noted the role of “broad-based escalation in cost-push pressures in services and manufacturing prices due to increase in industrial raw material prices”, “increased pass-through to output prices as demand normalises” and “firms regain pricing power” as possible tailwinds to inflation.
“On the economic outlook, RBI appears quite convinced of the growth recovery ahead and more cautious on medium-term inflation risks due to rising cost-push pressures. However, with the recovery yet to gain firm traction, it believes policy support is still crucial,” said a note by Sonal Varma and Aurodeep Nandi, economists at Nomura Global Markets Research.
With the central government announcing a higher than expected fiscal deficit and borrowing plan, experts also saw the MPC’s decision as an attempt to strike a balance between fiscal and monetary policy goals. “Today’s RBI policy statement, in our view, was an effort to tread the fine balance — highlighting the strength in economic rebound and upside inflation risks; and yet keeping the policy and liquidity stance clearly accommodative, so as to keep financial conditions from tightening too much. After all, the RBI has worked hard in 2020 to provide as large a stimulus as it possibly could. It would not want to turn it all around so quickly”, Pranjul Bhandari, chief India economist at HSBC Securities and Capital Markets (India) Private Limited, said in a note.
Some economists underlined the weak recovery in consumer demand and the possible headwinds it might face. “If RBI’s prognosis of non-food prices growing faster than food prices turns out to be true, we would see a worsening of terms of trade against agriculture”, said Himanshu, associate professor of economics at Jawaharlal Nehru University. “This could generate pressure on rural demand which has been an important support for the economy in the post-pandemic phase. When read with the continuing weakness in consumer sentiment, both fiscal and monetary policy would do well to not take an economic recovery for granted.”