Monetary Policy: Having Done Its Best, RBI Passes Baton To Fiscal Authorities

Hima Das, hands the baton to teammate Arokia Rajiv during the 4x400m mixed relay final. (Photograph: PTI)

Monetary Policy: Having Done Its Best, RBI Passes Baton To Fiscal Authorities


The Monetary Policy Committee’s unanimous decision to keep all the key policy rates unchanged and continue with an accommodative policy stance did not come as a surprise to anyone. The June 4 policy statement should not be seen in isolation, as the Reserve Bank of India had already announced a slew of measures on May 5 to combat the adverse impact of the second Covid-19 wave. We highlight the main takeaways below.

Open-Ended Accommodative Stance Maintained

Given the unprecedented uncertainty surrounding the near-term outlook, the MPC maintained the “state-based” guidance after having shifted from a “time-based guidance” in the April policy itself. We think this makes sense, as it will provide the necessary flexibility to the MPC to be nimble and swift-footed in taking appropriate actions based on how the economic conditions evolve over the next few months.

FY22 Growth Projections Lowered By 100 Bps, In-Line With Consensus Forecast

RBI lowered the FY22 real GDP growth forecast to 9.5% year-on-year, from its earlier forecast of 10.5% YoY, thereby converging with the current Bloomberg consensus estimate. Given the second Covid-19 wave, growth forecasts have been slashed significantly, so much so that our long-standing and unchanged FY22 growth forecast of 10.5% YoY, which was significantly ‘below-consensus’ in February has now become ‘above-consensus’!

But when the pendulum swings, it always swings more than what the equilibrium level would suggest.

We have seen that play out last year itself. When April-June 2020 GDP contracted 24% YoY, consensus came overly pessimistic and FY21 GDP projection was revised down to as much as 12% YoY contraction at one stage. Even RBI, in its October 2020 monetary policy statement gave a 9.5% YoY contraction forecast for FY21. At that time, we held on to our FY21 forecast of -8% YoY, which finally turned out to be better at -7.3% YoY. So the downgrade to growth forecasts in the current policy should be seen in that context.

There is no doubt that the localised lockdowns in all the states will impact India’s pace of economic recovery, but even then it may be possible to achieve 10.5% YoY growth in FY22 for the following reasons.

  • First, the base effect remains significantly supportive, as we are coming out of a record decline of 7.3% YoY in FY21.

  • Second, global growth recovery is expected to be stronger in 2021 (6% YoY+) relative to what RBI had factored in the April policy (5.5% YoY), which could add 20 bps incrementally to India’s growth.

  • Third, the nature of the current lockdown in all the states is different from the hard nationwide lockdown announced last year; therefore, while mobility has fallen to last year’s May/June levels, economic activity has not been that severely affected.

  • Fourth, if the mathematical model-driven predictions made by the IIT scientists—daily Covid-19 cases falling to 30,000 by end-June or early-July—is proven to be true, sentiments about future growth prospects could improve swiftly, with different state governments starting to prepare for a graded unlocking of the economy.

  • Fifth, given the volatility and the sizable revisions that are characteristic of India’s quarterly GDP data, it may make sense to wait at least for the April-June 2021 GDP data, before making any changes to the full-year forecast.

FY22 Average CPI Inflation Forecast Increased Marginally To 5.1%

With the growth rebound likely to be softer in FY22, we do not see a significant threat of genuine demand-side inflation pressure emerging anytime soon, as the output gap is likely to stay negative in FY22, limiting bargaining power related to wages at a minimum. Our own CPI inflation forecast for FY22 and FY23 stands at 5.0% and 4.7% respectively, with core CPI inflation (CPI excluding food, fuel, tobacco, intoxicants) expected to be around 5.1% on average.

G-SAP, Soft Yield Curve Control, And Liquidity Support

RBI enhanced the second tranche of the Government Securities Acquisition Programme or G-SAP 2.0 for July-Sep to Rs 1.2 lakh crore, from Rs 1 lakh crore in April-June, arguing that a lower April CPI print of 4.3% has provided it with “policy elbow room” to increase liquidity support. But that is unlikely to be the real reason, as CPI inflation will head to 5.3-5.8% in May and June, as per our estimates. We think the main rationale is guided by the need for front-loading monetary support, so as to keep bond market yields at the prevailing level of 6%, particularly when the economic momentum has slowed down significantly on a sequential basis.

It is quite possible that as the growth recovery gains traction from H2FY22, the RBI may start tapering its quantum of G-SAP support in subsequent tranches.

The policy statement mentioned that the focus of the central bank is “increasingly turning from systemic liquidity to its equitable distribution”, which is important in our view. This indicates that RBI’s tolerance level as regards the upper threshold limit of systemic liquidity has been reached and while the central bank may not reduce the quantum in the near term, it may not want to add further to it beyond this point. While it may be too early to talk about “normalisation” at this stage, our guess is that the October-December 2021 quarter could be a potential period when the central bank can look to take small steps to return on the path of normalisation. Tapering of G-SAP, increase in tenor and quantum of variable rate reverse repo auctions, and finally narrowing the corridor between repo and reverse repo rate could all be under consideration in the final quarter of 2021, in our view.

Targeted Liquidity And Regulatory Measures

RBI announced a few more targeted liquidity and regulatory measures in the current policy, over and above what was already announced on May 5 to lend support to contact-intensive sectors and MSMEs, which have been the most affected in the Covid-19 pandemic. We will need to wait for a few more months to understand how well the schemes (pertaining to May 5 and June 4) are working and whether they need further tweaking to make them more effective. At this stage, RBI has done its level best to provide as much support as possible to different stakeholders in the economy.

The baton now passes on to the fiscal authorities to announce further measures which can help to fast track the recovery in growth.

We expect fiscal announcements to come soon as the daily Covid-19 cases fall below the 1 lakh mark by mid-June and different state governments get ready to slowly start unlocking the economy in a phased manner.

Kaushik Das is India Chief Economist, Deutsche Bank.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.

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