The Reserve Bank of India (RBI)’s June monetary policy will be announced in the backdrop of mixed signals on growth and inflation. The lockdowns in multiple states have hurt the fledgling economic recovery and most forecasters have lowered FY22 GDP growth projections by 1-3 percent.
Manufacturing sector PMI was at a 10-month low of 50.8 in May while urban unemployment rose to a 1-year high of 17.9 percent. However, this year’s lockdowns have been less harsh than last year’s and, therefore, may have been less costly for the economy. With lockdowns expected to be lifted soon, we could see a rebound in growth in the coming months.
While the retail inflation print was 4.3 percent in April (close to the RBI’s target of 4 percent), WPI inflation was at an 11-year high of 10.5 percent. Global commodity prices have been rising thanks to economic recovery in the developed world. As higher input prices may get passed on to consumers, worries of a retail inflation spike remain. But imminent dynamics such as a favourable monsoon and fresh supplies may soften prices.
The Taylor rule with a negative output gap suggests that there is room for a repo rate cut. But most analysts have flagged inflation risks to predict that the RBI will continue to hold the repo rate at 4 percent and maintain an accommodative stance i.e. provide liquidity through conventional and unconventional means. However, as the -7.3 percent growth print of FY21 shows, this is not going to be enough. The RBI has to re-imagine monetary policy in the face of K-shaped growth where some sectors are hit harder than others due to no fault of theirs.
To be fair, the central bank has ensured that interest rates have come down over the last year. As a result of the repo rate cuts and massive liquidity infusions since last year, the marginal costs of funds-based lending rate (MCLR) decreased by 90 basis points over FY21. Unfortunately, lower rates have not translated into credit growth. Bank credit grew at 6 percent in 2021 as compared to 6.5 percent in 2020. Monetary actions transmitted to lending rates but not to the real economy or bond yields.
One option is to reduce the cash reserve ratio (CRR) even though it would go against the recent rollback of the CRR cut of last year. Or the RBI could introduce targeted CRR cuts i.e. exempt banks from the CRR to the extent of their new loans to stressed sectors of the economy. Job-creating sectors like mining, automobile and construction have seen a decline in credit growth in the COVID-19 second wave. The rural economy has also been hit hard with micro finance institutions (MFIs) facing drop in collections. While the RBI had earlier exempted banks from the CRR on fresh credit to the MSMEs, that applied to first-time borrowers for loans up to Rs 25 lakh. This time the RBI can reward banks with the CRR relief for any amount of loans to select sectors.
Second, given that the reverse repo rate is now the effective policy rate (with the interbank rate hovering around it), the RBI can cap the amount banks park at this rate and create a standing deposit facility with a lower rate. This will discourage banks from parking funds with the RBI and prod them to lend. Third, as the RBI has built credibility over five years of inflation targeting, it can issue bolder forward guidance with contingent paths for its policy instruments along with estimated fiscal stimulus necessary for stabilising the economy. This will provide clarity to financial markets and nudge the fiscal authority.
The RBI may enhance the scope and size of some of its unconventional policies such as targeted long term repo operations (TLTRO), operation twist, variable reverse repo (VRR) and government securities acquisition programme (G-SAP), while announcing new ones. Lastly, on the regulatory front, the RBI may consider relaxing capital or liquidity regulations for banks to help them lend more.Rudra Sensarma is Professor of Economics, Indian Institute of Management Kozhikode. Twitter: @RudraSensarma. Views are personal.