Since the last monetary policy meeting in early April, it seems like the world has changed, at least for India. COVID-19 2.0 has caught the country unawares. As we were preparing to get back to the way things were, on the back of a good fourth fiscal quarter of economic activity, the virus has hit the country, its people and the economy with a virality that has caught us off guard. When the Monetary Policy Committee (MPC) meets for the second monetary policy of FY2022, COVID 2.0 and its impact will be the most defining factor in its deliberations.
The two phases of the pandemic
Things were looking very different a few months ago. Consumption and growth had slowly started to recover in the September-December quarter last year. The January to March quarter was close to normal on most key metrics. But by the middle of April, as the pandemic spread across states with a relatively higher mortality rate, local restrictions/lockdowns hurt demand and consumption, which started moderating and slowed down even further in May. Consumer Price Index-based (CPI) inflation moderated on the back of softer food prices while Wholesale Price Index (WPI)-based inflation surged.
There are some clear and sharp differences between the two phases of the pandemic. In COVID 1.0, we feared all was lost, not knowing if the world would ever emerge out of its shadows. It was the fear of the unknown. Now, we are reasonably confident that it is a question of when. Last year, the impact on businesses and livelihoods was much deeper with extended nationwide lockdowns. However, this time around, the intensity of the virus in terms of its infectious rate and the severity of the disease with mortality rates rising steeply has acutely affected the consumer psyche. While public memory will be short in the medium-term, consumer spending in the near-term, especially on discretionary items, will be impacted at a time when households have to account for a sharp increase in healthcare expenses. COVID has also spread its tentacles deeper into rural India this time around. And lastly, there is the fear of Phase 3.
The issues facing the MPC
COVID 2.0 has again put growth and consumption on the back foot. GDP estimates have been revised downwards by 1.5% to 3% from original estimates. In the last one year, the central bank has ensured support to economic growth through ample liquidity and interventions to ensure that interest rates remain stable and soft. This stance is likely to continue in the second wave of COVID-19 till the economy returns to sustainable growth.
CPI inflation has softened in April on the back of stable to lower food prices but WPI inflation hit an alltime high of 10.5% in April 2021. Given the expectations of a rise in global commodity prices, inflation is likely to trend higher towards the end of FY’22. But price stability will be a key objective and the central bank is likely to intervene with measures to ensure the same. We have seen RBI expand its balance sheet including monetisation of debt to keep rates stable in light of the aggressive fiscal borrowing programme of the government.
Under these circumstances, the MPC will ensure an accommodative monetary policy focused on ensuring ample system liquidity, which will keep interest rates stable. Focus will be on growth to spur investment and consumption.
Globally, the major world economies are slowly getting back on their feet with vaccinations in full force. The US recorded consumer inflation at 4.2% in the month of April – the highest since 2008 when the recession hit, thanks to the spending stimulus from the Government to combat the impact of the pandemic. Rates in the US could see gradual hikes if inflation continues its higher trajectory.
The way forward
The single-point agenda for the Government and the MPC has to be to bring growth back. Investments in infrastructure, building healthcare capabilities, education are key. The twin engines of investment and private consumption need to be revived for sustainable economic growth post COVID.
The MPC, on its part, will have to use the tools in its arsenal to keep rates soft, support growth and introduce liquidity in the economy. However, monetary policy alone cannot achieve the above objective. It will have to be a combination of fiscal and monetary measures. The Government has just announced the expanded scope of the Emergency Credit Line Guarantee Scheme (ECLGS) to include more sectors as well as extending the tenure/ credit limit in some cases, which is a step in the right direction and will help support MSMEs and others.
Needless to say, an aggressive vaccination programme is the need to of the hour so as to reduce any impact if there is a third wave. It does look like there are not too many alternatives in front of the MPC right now. In this scenario, the committee will maintain a status quo on rates, continue with an accommodative policy stance and ensure adequate system liquidity with an all-out focus on growth.
(The writer is the group president – consumer banking, Kotak Mahindra Bank. Views expressed are personal)