Monetary Policy: After Government, RBI’s Time To Further Support Ongoing Recovery

According to a report in Bloomberg Quint, With the FY23 budget presented on Feb. 1, 2022, all eyes are now on the monetary policy review of the Reserve Bank of India. RBI so far has maintained its accommodative policy stance and time and again articulated that it will retain this stance as long as necessary to revive and sustain growth on a durable basis while ensuring that inflation remains within the range target going forward.

In its assessment of the domestic economy at the time of the last policy review, the RBI had said that economic activity is gaining traction aided by expanding vaccination coverage, the rapid subsiding of new infections, and the release of pent-up demand. It also said that both rural and urban demand is exhibiting resilience. While continued direct transfers under the PM Kisan Scheme are supporting rural demand, urban demand is improving due to rising consumer optimism and festival demand. RBI’s assessment of the global economy though was less sanguine. It felt that supply chain disruptions and elevated energy and commodity prices continue to weigh on global economic activity and the expected policy normalisation in advanced countries has unsettled global financial markets leading to renewed bouts of volatility and heightened uncertainties.

Economic Shifts Since The Last MPC Meet

Both domestic and global macroeconomic environment has changed since the last policy review mainly due to the rapid spread of the omicron variant of Covid-19. Thankfully, infections caused by omicron have so far been milder and not as life-threatening as prior waves. Even hospital infrastructure has not been inundated the way it was during the second wave of the pandemic and the curbs imposed by local and state governments were less disruptive than the earlier waves. Yet it created a fair amount of uncertainty with respect to human lives, livelihood, and macro-economic environment giving a push back to the normalisation of economic activities. Although governments, businesses, and economic agents are now better prepared and equipped to deal with such a situation, the worst-affected once again has been the contact-intensive services sector activities.

On the industrial front though, the impact of omicron has been minimal, but it still has not been able to recover from the impact of the second wave. A glance through the index of industrial production data will substantiate this point.

At a use-based level, the output of all industrial segments namely primary goods, capital goods, intermediate goods, infrastructure/construction goods, consumer durables, and consumer non-durables had recovered after the first wave and gone past the level of pre-Covid level of February 2020. However, after the second wave of Covid hit in 2021, the output of all the use-based industrial segments fell below the pre-Covid level were still below that level as the third wave of infections rose in the last couple of months.

The Case For Staying Put

No doubt the ongoing domestic recovery has strengthened with the expanding vaccination coverage, it still is uneven and fragile. The National Statistical Organisation’s advanced estimate of FY22 shows that private final consumption expenditure which is the largest component of GDP (58.6%) from the demand side and a proxy for consumer demand, registered a YoY growth of only 4.1% in FY22, despite a low base and sales data of many consumer durables showing robust growth in FY22. In fact, the slowdown in PFCE had begun even before Covid-19 pandemic hit the Indian economy. PFCE growth had declined to 5.2% in FY20 from 8.1% in FY17. The decline was even sharper on a quarterly basis where PFCE growth declining to 2.0% in Q4FY20 from 11.2% in Q3FY17. The pandemic and subsequent lockdown only aggravated it as jobs, livelihoods, and household budgets were severely dented and PFCE witnessed a degrowth of 6.0% in FY21.

The broader thrust of the FY23 union budget on growth via higher capital expenditure, the performance-linked incentive scheme, recovering private corporate capex, would need benign liquidity and accommodative financial conditions.

This would mean that RBI should retain its ongoing stance and maintain the status quo on the policy rate.

Global Commodity Prices

But volatile global commodity prices, continued disruptions in the global supply chain coupled with a spike in select food items pose risk to inflation and inflationary outlook. Under weak demand conditions, producers normally refrain from raising prices due to the fear of reduced sales volume and/or market share. However, the current inflationary trend shows that despite weak demand increased input cost is being passed into the output prices. This suggests the regaining of pricing power by the manufacturing firms. Retail inflation, the nominal anchor for RBI, so far in FY22, has mostly been close to the upper band, despite the high base of FY21. Wholesale inflation is in double-digits since April 2021.

Global inflation too is expected to remain elevated in 2022, due to falling unemployment, sustained demand, and supply tightness. Crude oil prices will be an important factor to watch. Both crude oil and natural gas prices are expected to be slightly higher in 2022 than in 2021 due to geopolitical situations – particularly the military build-up on the Russia-Ukraine border and fresh turmoil in West Asia. In response to higher inflation, central banks of advanced economies are expected to tighten the monetary policy this year. Bank of England has already hiked its main bank rate to 0.5% from its historic low of 0.1%. According to the dot plot, the U.S. Federal Reserve is expected to go for three rate hikes in 2022.

Elevated domestic inflation coupled with an expected increase in the policy rates by central banks of advanced economies would no doubt put pressure on RBI to begin unwinding the accommodative monetary policy pursued so far. However, given that the economy is still not out of the woods, and the union government has already reaffirmed its commitment to support the ongoing recovery via fiscal push, RBI would do well to continue with its accommodative stance. This means not only retaining the policy rate at the current level but also articulating its earlier view of continuing with an accommodative stance as long as necessary to revive and sustain growth on a durable basis. (Bloomberg Quint)