When a virus makes policy-making easier for RBI

Photo: Mint
Photo: Mint


The variant’s effects could be among the factors that’ll ease RBI’s trade-off of growth and inflation

The newly identified Omicron variant of the covid-causing Sars-Cov-2 virus is a rude shock to many of us who were fervently hoping that we could put the worst days of the pandemic, with its lockdown disruptions and health fears, firmly behind us. This might still be the case, but for now the jury is out. However, to the extent that it dampens sentiment in financial markets, it might turn out to be a source of relief for the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), which meets for three days starting on 6 December.

At the outset, there is no reason to change our view of India’s economic growth estimate of between 9% and 10% for the full financial year 2021-22 and the inflation outlook of around 5-5.5% for the same period. Between the last monetary policy meeting and this one, developments in the country’s real economy have been in the general direction of reduced contradictions faced by the central bank. To elaborate, RBI was beginning to face increasing tension between its objectives of accommodating economic growth and restraining inflation. To an extent, the trade-off between the two had lessened due to several developments.

One, international crude oil prices that were beginning to look like a threat have declined. Indian stock markets are a little less exuberant and may become even less so in the days ahead as they follow global markets in reacting to the uncertainties posed by the new variant of the covid virus.

Two, on its part, the Indian government lowered some fuel taxes and so did state governments. While that leaves some money at the margin in the hands of the people, it lowers inflation pressure too.

Three, international shipping rates that were soaring have declined a bit, and so have international prices of coal, iron ore and steel.

Four, internationally, a surge of covid infections in Europe and the likelihood of a harsh winter in the US and Europe, which could impact energy demand, have made economic growth prospects uncertain. American labour-market and consumption data appear good for now, but a recession is only one financial market crash away. In fact, the underlying situation in Europe is a lot more fragile than is commonly realized. Social, political and economic cohesion within the Eurozone may come under increasing strain from here onwards, especially if the new variant crashes economic activity in the region in 2022.

While, in theory, the reappointment of Jerome Powell as chair of the US Federal Reserve, quashing speculation on the appointment of Lael Brainard in his place, should not matter from a policy perspective in the long run, there is an issue of optics that should be taken into consideration. Specifically, Powell will be a wee bit less dovish than Brainard. But, should a re-appointed Powell signal adherence to the currently expected timeline for a Fed taper and end special bond purchases by mid-2022, and if US asset markets begin to correct consequently, it would solve a lot of problems and resolve trade-offs for India. Alternatively, in the light of the new variant, if the Fed were to postpone consideration of lowering its bond purchases, that too would ease the decision-making burden on the MPC of RBI.

Should the Fed’s tapering commence in December and be continued at the same pace in the New Year amid elevated uncertainties, financial markets are very likely to undergo a deeper correction. Such a stock market correction in the US, with its spillover effects on other markets and the real economy, will likely also ease supply-chain bottlenecks as aggregate demand would slow down in developed economies. Commodity prices, including the price of crude oil, will decline further. RBI will also have to worry about inflation less in that case.

However, in my view, the price of crude oil in the medium-term would begin to rise on account of the chaos likely to be associated with the world’s green transition. That is going to be costly, disruptive and possibly even futile. India should use lower oil prices to prepare itself for higher prices.

Further, if this scenario materializes, India’s export growth, which has been a success story so far this financial year, will also slow down. All else being equal, that will also act as a dampener on economic growth, further reducing the tension between a growth-friendly and inflation-fighting policy stance.

As far as household inflationary expectations are concerned, data from RBI surveys shows that, on average, more than 50% of its survey participants expect year-ahead inflation to be over 10%, a figure well above RBI’s target. In this, households seem to be influenced by two things: an earlier experience, over five years, of nearly uninterrupted double-digit inflation between 2009 and 2014, and two, the current experience with food and fuel pump prices. One thing that our central bank has to watch for is the persistent increase in that proportion of respondents above 50%. Right now, it is a shade under the halfway mark. As long as the RBI survey indicates that it is not too far above 50%, it can be comfortable with its accommodative stance.

V. Anantha Nageswaran is visiting distinguished professor of economics at Krea University. These are the author’s personal views.


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