It was anticipated here one month ago the GDP contraction in the lockdown quarter of April-June could be unexpectedly severe, seeing the GST revenues and corporate result trends. The -23.9 percent GDP fall has exceeded most predictions since. The probable decline is even steeper as the unorganised segment (about 47 percent share), initially assessed by large companies’ performance, is not yet fully captured.
The unexpected, large growth shock comes amidst a rapid virus progression across the country — another unanticipated and adverse development. It also arrives amidst rising inflation. Each of these combine to thicken the fog around macroeconomic policies.
The context has seriously darkened. Growth forecasts for the pandemic year 2020-21 have savagely doubled down — from -5 percent ranges to -10 percent regions now. Headline inflation in the while, has stayed constant at 6.7 percent in July and August. Together, these have firmed a stagflation environment whose duration is immensely uncertain.
Not only do the growth-inflation dynamics depend upon the pandemic’s evolution, but also upon the pre-existing stress and progression of food and core inflation. It is now a year that inflation has been rising. It hasn’t eased as the central bank expected at the year’s beginning. Similarly, the households, business, financial and government sectors were already in weak states, negatively impacted by COVID-19 as the GDP data shows. How the broadening, long-drawn infections affect growth and inflation trends are confusions for policymakers amidst the pandemic’s uncertainties.
From a fiscal policy perspective, these adverse developments imply three things. One, the sharper-than-foreseen GDP decline means larger shortfall in public revenues than assessed before or that government borrowings will exceed the Rs 12 trillion announced for the year, creating uncertainty about the amount of additional bond supplies.
Two, in combination with a rising infection curve, a more aggressive fiscal response may be required. Recent reports say the government is contemplating an urban-MGNREGA to support low-income groups affected by unemployment and wage erosions; before this, there was reported intent of a second-round fiscal response timed for stimulating recovery. No concrete announcement is made on either so far, but expectations of higher public spending have been engendered. Finally, the interest rate pressures from escalated inflation-fiscal risks have drawn strings tighter on public spending.
On the monetary policy side, inflation rigidity above 4 percent (with +/-2 percent band target) and general spillover fears from food inflation expressed by two RBI members at the last review meeting had already raised inflation risk premia. Despite central bank intervention and signalling, the benchmark 10-year bond yield proved irrepressible.
Ahead of the GDP data release on August 31, the RBI attempted to soothe inflation fears through open market operation (Rs 200 billion in two lots) announcement with commitment to continue as needed, allowing banks to reverse past long-term repo borrowings (LTRO) at lowered policy rate, and easing held-to-maturity investment limits. Also, in an unusual departure from past talk-up or directional guidance on exchange rate, the central bank pointed that “...the appreciation of the rupee is working towards containing imported inflationary pressures”! These didn’t help much as observed from the elevated reference bond yield. Fiscal risks have joined inflation ones since to harden this above 6 percent, while two more auctions devolved in the RBI-bond market tussle.
The policy fog arises from the pandemic. If its longevity was known, the government would have had a better grip on fiscal risks and revise its metrics for everyone’s assurance. Likewise, the RBI could anticipate and interpret inflation evolution more easily, e.g. how long could the transitory supply disruptions last, how long could uneven price pressures from changes in consumer expenditure patterns persist, or the most important decision — if disinflationary pressures from contracting demand are lurking underneath the supply-side pressures.
The growth picture is less clouded. Even before, the indications were that returning from the April-June trough wouldn’t be quite as sharp; restoration to trend, if at all possible, would take long. This was based upon past weak states of each sector, particularly the financial system, and low fiscal ability to counter significant injuries inflicted upon people and businesses by the national lockdown in large part of the first quarter. The elongated pandemic spread points to a plodding revival. On September 16, the RBI Governor said recovery would be gradual, hinting of possible damages to productivity, and the policy efforts that could restore growth to actual potential.
Reconciling to a drawn out infection curve is realistic. This will not disperse the policy fog or lessen macro risks of inflation and fiscal overextension. However, it helps recognise the imminence of more income support for poorer populations. That’s necessary from the pandemic standpoint and if only to reduce the increased growth risks.
Renu Kohli is a New Delhi-based macroeconomist. Views are personal.
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