RBI MPC is set to announce its policy choices later this week. It has so far deftly juggled amid its objectives of inflation, bond yields and the rupee.
By Churchil Bhatt
The Covid 19 pandemic has fueled the concerns of a ‘K-shaped recovery’. Shape K contrasts the fate of businesses suitable to adapting in a post-Covid world versus those finding it difficult to make the transition. The IMF has already warned about a ‘Great Divergence’ whereby growth in DMs and select EMs may recover soon, while the rest may lag behind by years. Even within economies –sectors such as travel and hospitality lag far behind IT and pharmaceuticals.
The pandemic has pushed policymakers to deliver immediate and extraordinary monetary and fiscal policy responses. Much like Frost’s ‘two roads that diverged in a wood’, policymakers have taken ‘the one less traveled by’ this time. While along this path they have rescued financial markets and prevented economic collapse, they have also accentuated a host of disparities, many unintended. Looking closely, we explore a few such roads that have diverged in the shape of K.
Most talked about, and probably the least understood, of the Ks is the divergence between economic growth and employment. With CY2021 GDP growth likely to be 6.4%, US economy may surpass the pre-pandemic growth. The US labour market is however 8.2 mn workers short of the pre-pandemic level. While part of this may be explained by lack of incentives to work given the stimulus cheques, there is a lot of uncertainty around the post Covid employment trend. CMIE India unemployment rate has risen sharply to 11.6% in May 21 from 6.15% in March 21. The disparities seem to further accentuate within the labour market. Low wage workers, especially in contact-intensive services, have found it difficult to find employment while workers in financial services and technology have worked from home and even benefited from higher savings.
Adding a few more Ks to the economic landscape, advanced economies are currently far ahead on growth and vaccination front compared to EMs. Nearly 40% and 35% of the population in the US and UK is fully vaccinated as against 3% in India, 8% in Russia, and 10% in Brazil. This may lead to diverging monetary policies going forward. Indian Bond Yields have already diverged from their US counterpart this FY guided by RBI. Yet, India’s 1-year forward premia rates continue to follow an altered trajectory away from 1Y T Bill yield. World over, Central Banks have already risked a divergence from traditional Inflation Targeting and persisted with prolonged accommodation in search of the elusive durable growth.
However tricky it may be, policymakers are trying to address a few of the above avoidable contradictions. Most have already voiced concerns about rich market valuations and have started preparing markets for an eventual Taper. At the same time, they have announced their near-term intention to look through the recent episode of higher inflation and remain accommodative, thereby giving real economy a chance to catch up with asset markets. Uneven distribution of QE benefits is being partly offset by direct cash transfers and proposals to increase taxes in future. EMs including India are also making a serious attempt to bridge the vaccination gap with DMs. This may in turn reduce the gap in economic recoveries across countries.
Given this backdrop, the MPC is set to announce its policy choices later this week. It has so far deftly juggled amid its objectives of inflation, bond yields and the rupee. But given the abundant liquidity surplus, continuing Forex inflows and more recently the incremental borrowing of Rs1.58 tn on behalf of states, RBI may find it difficult to manage the impossible trinity for long. Hence, going forward RBI may gradually pass on the onus of supporting growth to the government. In doing so, the RBI may endeavor to keep local markets orderly. Near-term headline inflation remaining within the RBI’s comfort zone should help this cause. We, therefore, expect MPC to persist with its accommodative policy stance, keep plentiful system liquidity and strive for an orderly evolution of yield curve using all available tools while it prepares markets for an eventual gradual Taper.
(Churchil Bhatt is EVP Debt Investments, Kotak Mahindra Life Insurance Company Limited. Views expressed are the author’s own.)