The RBI’s Monetary Policy Committee kept key rates unchanged and maintained an accommodative stance in its October review. As expected, the policy statement was conciliatory. Clearly, Mint Road does not yet want to label the ongoing recovery as sustainable. As a corollary, it will tend to tolerate inflation until the Covid-19 pandemic subsides significantly and there is a broad recovery.
It is important to remember that monetary policy these days is influenced both by local macroeconomic developments and by the stance of global monetary policy, the former playing a dominant role. Locally, after the second wave of the pandemic, a variety of indicators such as the purchasing managers index (industry and services), mobility indicators, government tax collections, exports and imports indicate improvement. of economic activity. CRISIL estimates real GDP growth at 9.5% for the current fiscal year. And nominal GDP growth is expected to be much higher at 17 percent due to high inflation.
Then there is the good news on the monsoon front. With a late resumption of rains, the cumulative deficit for this monsoon season has fallen to just 1 percent of the long-term average (LPA). In addition, seedlings are now at 102 percent of normal levels. Despite an uneven spatial distribution and some damage caused by the late rains, nothing indicates a major disappointment. Average dynamic storage in reservoirs has exceeded the 10-year average and reached 80 percent of its capacity. This bodes well for rabi crops, which depend on irrigation. Therefore, we expect agricultural GDP to grow by 3% in this fiscal year.
Granted, since the MPC’s policy review in August 2021, Covid-19 cases have tended to decline and there has been admirable progress on the vaccination front. But there is no room for complacency – the virus is on the decline, but certainly not extinct. Global experience, even in economies that are sufficiently vaccinated, shows that vaccines attenuate the virus but do not beat it – at least, not yet. The intensity of the third wave remains a major risk to growth and well-being for the rest of this fiscal year.
In addition, despite high growth figures year on year, the level of economic activity for this fiscal year will be only 1.5% higher than 2019-2020. Both investment and private consumption remain low. But there are other puzzling trends as well.
Of course, the government is doing its part. Central and state capital spending is on track to meet budget commitment, supported by sound tax collections. And large companies in industrial sectors such as steel, cement, non-ferrous metals are operating at healthy usage levels and have deleveraged their balance sheets.
But walking is not so good for the little ones. Analysis by CRISIL Research shows that in the last fiscal year, the utilization of India’s top five steel producers averaged 81 percent, compared to 62 percent for the rest. For the top five cement manufacturers, it was 71 percent against 54 percent for the others. Investments in brownfields are made by large companies. Obviously, small businesses need political support. The extension of the guarantee mechanism for emergency credit lines is a recognition of this.
Private consumption is not generalized either. Even in the consumption of goods, which is doing better than services, the nature of demand seems skewed towards relatively higher value items such as cars and commercial vehicles (now plagued by semiconductor shortages). On the other hand, the demand for cheaper items such as two-wheelers remains low. This likely reflects the income dichotomy created by the pandemic. And also, while the annual growth of air conditioners, televisions and washing machines may be in double digits this fiscal year, it is unlikely to exceed 2019-20 levels.
As for inflation, its fall to 5.3% in August offers only limited comfort for two reasons. First, core inflation and fuel inflation, which weigh 54% in the CPI, remain stubbornly high and will remain so for a few more quarters given rising crude oil prices, persistent disruptions. supply and skyrocketing freight costs.
Second, food prices lowered headline inflation. The high base effect of food will be in play until the end of 2021 and after that, non-food inflation will subside as the supply side disruptions subside. This appears to underlie the RBI’s reduction of the CPI forecast to 5.3 percent from 5.7 percent for the current year.
The national dynamics of growth and inflation suggest that the RBI has no choice but to remain more tolerant of persistent price pressures, and hopes that these will eventually prove to be transitory as they have were mainly driven by supply shocks caused by the pandemic.
Overall, the monetary policy environment is moving towards normalization / tapering / rising interest rates largely due to a surprise rise in inflation, or because some central banks believe that quantitative easing targets have been met. Central banks in advanced economies such as Norway, Korea and New Zealand recently hiked rates, while those in Australia, Sweden and the UK cut back on asset purchases. Emerging countries, especially those following an inflation target, have started to raise rates. The two systemically important central banks – the US Federal Reserve (Fed) and the European Central Bank (ECB) – view the current surge in inflation as fleeting and have expressed greater tolerance for it for a long time. longer period. While the Fed has brought forward its reduction schedule, the ECB does not seem in a rush.
We believe that the process of wiping off excess liquidity will slowly accelerate over the next few months, followed by a hike in policy rates towards the start of 2022. By then there should be sufficient clarity on the third wave and the position of the Fed and the Fed. ECB, which would hold their review meetings in mid-December of this year.
Joshi is Chief Economist, CRISIL Ltd
