Certainty on interest rate path by RBI and clarity that the government will not risk more borrowing than committed are immensely helpful
The past one week has brought considerable clarity about policymakers’ views on the evolution of key macroeconomic variables ahead, and the extent of further policy assistance they are able and willing to provide. Between monetary and fiscal policies, it is the former that imparts confidence to the economic environment.
Six months from COVID-19’s onset, the Reserve Bank of India (RBI) finally presented its inflation and growth forecasts for 2020-21. Though subject to considerable uncertainty, especially about inflation with singular downside risks to growth, these disperse the past fog on these. However, it is the monetary policy committee (MPC) commitment to continue the current accommodative stance into the next financial year and look through the temporary inflation spike that has injected confidence.
Then, clarity about further fiscal stimulation, reported about for quite some time, also appeared, albeit in a subdued approach. These developments clear the air while monetary policy delivers a big punch. It goes without saying that recovery will depend much upon the future course of the pandemic, as on attendant policies where the fiscal aspect is too weak.
The crux of the change in environment comes from the monetary policy. The MPC decided to shift focus exclusively upon the large negative output gap arising from a projected -9.5 percent contraction in real GDP this year. It assured to stay the current course for next three quarters, at the end of which (April-June, 2021), inflation is seen close to target, or 4.3 percent. The consecutively high inflation that touched 7.34 percent in September is due to supply-side, transitory factors.
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The MPC’s decision to see through the above-target inflation phase, and stay the course assures investors and borrowers alike. Not only will the policy rate status quo remain for the next three quarters, should there be no upside inflation surprise and the RBI is sure of reaching its 4.3 percent CPI inflation forecast for April-June 2021, it will ease further for growth support.
Nothing could better this forward guidance. The biggest testimony for this comes from the bond market’s response to September inflation outturn released two days after the review on October 12. The benchmark 10-year bond yield (5.77 percent) remained stable around 5.9 percent, held by this categorical assurance and complete certainty about the interest rate path during the pandemic’s uncertain times.
The government too announced its demand stimulus, the second-round of which was reported to be in the pipeline. This failed to impress and have any positive impact because of its small size (about 0.2 percent of the GDP), its terms and conditions, and its anticipated impact on consumption and investment demand that the government places at Rs 730 billion or 0.4 percent of the GDP.
This is feeble and does not respond to increased evidence from data that underlines an uneven recovery with some sectors, and income-employment segments hit harder by COVID-19 and facing darker prospects than others. For example, services lag manufacturing; within the former, more in-person contact ones such as hospitality, travel, tourism and numerous personal services, are especially hurt by the pandemic.
Nonetheless, the clarity about the government’s determination to not incur any risk from further deficit expansion and debt accumulation by higher fiscal spending than already committed is helpful.
With the course of macroeconomic policies clear for rest of this year, what is the outlook for recovery? The RBI’s -9.5 percent contraction for FY21 is subject to downside risks, challenged as it is by COVID-19’s spread and future course. Based upon full restoration of supply chains, effective vaccine availability, a normal monsoon, no major exogenous or policy shocks, and a large favourable base effect, the RBI’s best-case scenario projects a rebound to 10.1 percent in 2021-22, implying that real output will return to 2019-20 level within one year. The IMF’s World Economic Outlook projection, released on October 13, assesses a deeper decline in comparison at -10.3 percent, followed by 8.8 percent growth in 2021-22 (projection). All other private sector and agency forecasts do not predict restoration to FY20 output level within a year.
Assuming 6 percent inflation this year, nominal GDP contraction would be -3.5 percent in the most optimistic case. The average Indian therefore, who earned Rs 151,677 in FY20 (Rs 12,639.8 monthly), is expected to face a likely loss of Rs 442 each month in this scenario as their average takeaway income shrinks because of COVID-19 .
In 2021-22, the following year, if nominal GDP grows 14.1 percent as predicted by RBI (adding 4 percent inflation to the projected 10.1 percent), this would lift annual GDP per capita to Rs 167,006, or a Rs 1,720 increase in average monthly income. It is to be hoped this optimistic scenario materialises and the income decline is temporary and short-lived despite one of world’s least fiscal support. This optimism, however, is not shared by the IMF.Renu Kohli is a New Delhi-based macroeconomist. Views are personal.