Second surge has hit recovery, and the pain could linger for some time; despite discomfort, RBI must keep monetary policy easy
The latest round of high-frequency indicators makes it clear the economy is losing some steam; in the seven days to April 25, the NIBRI—a business resumption tracker—registered its steepest weekly fall in over a year (of 8.5 percentage points), to 75.9. This is about 24 percentage points below the pre-pandemic normal. This is not really surprising given the restrictions imposed by several states following the ferociousness of the second wave of the pandemic.
The bad news is that it could get much worse before it begins to get better. One reason for this is the painfully slow rollout of the vaccination drive; consumers are likely to remain cautious until a significant chunk of the population has been inoculated. In its recent update on the economy, RBI has red-flagged that if the resurgence of the virus is not contained in time, it would lead to restrictions being in place for a longer time, which in turn could disrupt the supply-chain and stoke inflation.
Moreover, it notes that when inflation traverses beyond the ‘comfort zone’, the exclusive concern of monetary policy must be to bring it back to the target levels. Ostensibly, this means the central bank would be uncomfortable if inflation persists beyond 6% for more than three to four months at a stretch. Inflation did spike towards the close of 2020 and stayed elevated for a couple of months before trending down to 5.5% in March; economists have warned core inflation could remain sticky at levels of about 6% for various reasons especially the rise in the prices of commodities.
The central bank has reiterated its accommodative stance reassuring the bond markets liquidity would be adequate. However, the bond markets remain apprehensive and are unwilling to buy government securities below a certain yield as seen in the lukewarm response to the last couple of bond auctions.
These are extraordinary times—the second surge with new variants of the virus is turning out to be far more life-threatening than anyone had imagined—and the central bank will surely take cognisance of this as it reviews its policies over the next few months. Given how the recovery could get a bit of a jolt before it gets going again in the second half of the year, the central bank can be expected to look through inflationary pressures, at least in the near term, while keeping a close watch on asset bubbles.
It is true rising commodity prices could push up the import bill and also that gold imports have been rising. Fortunately, RBI is sitting on close to $600 billion of forex reserves that will come in handy in the event of any major dollar outflows. Right now, growth needs to be supported; while the formal economy is becoming stronger, the informal economy is in trouble. An easy monetary policy would ensure interest rates remain affordable and would facilitate credit flows.
The larger banks may have decided that they will lend very selectively—loan growth has slumped to sub-6% while the surplus liquidity is some `6 lakh crore—but other financial intermediaries continue to back small enterprises. RBI did a good job of managing the government’s borrowings in FY21 and while the borrowings in FY22 are large, the money must be mopped up to enable government to spend. If monetary policy needs to be accommodative, so be it.