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No monetary tightening in foreseeable future

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It is also possible that the MPC will revise downwards the real growth projection by 50-75 bps but not revise upwards much the CPI inflation projection describing it as a transitory phenomenon rather than permanent

With resurgence in the Delta variant of Covid-19, concerns have resurfaced over the global economic outlook. Otherwise also, recent data for the US and China (which account for more than half of world growth) suggested a slowdown in the strong pace of global economic recovery alongside rising prices of many commodities and raw materials. While labour shortages and supply chain disruptions have slowed the US economic expansion, continued weakness in domestic demand remains a major concern for China. And now with the Delta variant casting shadow over global recovery, the narrative seems to have changed from ‘look at how inflation is rising!’ to ‘look at how growth is slowing!’, reports the Financial Times. As ever, the developing economies like India will remain the most vulnerable to the spread of Delta, with minimal access to vaccines and limited policy space.

Factoring in these concerns, the systemically important global central banks like the US Federal Reserve or European Central Bank or People Bank of China have continued with easy money policies in their recent policy reviews in July, 2021 citing the downside risks to economic outlook.

Indian economic growth scene is also not very encouraging. While a few economic indicators improved sequentially in June, 2021 after falling in May, the growth is highly uneven. Some sectors like ‘logistics’ have surpassed the pre-Covid level but others like industrial activity, fuel and power sectors are still below the pre-Covid levels. GST collections have plunged below the 1 trillion mark for the first time in eight months. Sequentially (month over month), banks’ non-food credit growth has deteriorated in recent months. Both manufacturing and services PMI prints have fallen significantly below the 50 point mark and employment scene has worsened in Q1, FY22 compared to that in Q4, FY21. Furthermore, uneven and patchy monsoon rains have hit total area under kharif sowing, especially for pulses and oilseeds. At a time when the government is under pressure because of high oil prices, higher prices for pulses and edible oils pose further upside to food inflation. Both WPI and CPI inflation rates have been steadily rising in recent months and the headline CPI inflation – a nominal anchor of the policy – has been staying above the RBI’s tolerance level.

Moreover, low vaccination rate makes India vulnerable to upcoming waves of the pandemic. Only 7.3% of India’s 1.37 billion population was fully vaccinated until 28th July, 2021. This poses risks to the prospects of a meaningful and sustainable economic recovery.

Against this backdrop, the monetary policy committee (MPC) of the RBI will avoid tightening the policy in foreseeable future. Rather, it will revise the timelines for normalisation even if it sees the build-up of inflationary pressures, primarily from the supply-side factors. As warned by the IMF, “the recovery is not assured until the pandemic is beaten back globally."

It is also possible that the MPC will revise downwards the real growth projection by 50-75 bps but not revise upwards much the CPI inflation projection describing it as a transitory phenomenon rather than permanent.

Given the global uncertainty over the Covid spread and the consequent economic adjustments, one does not expect monetary policy tightening in India in the year 2021-22. However, the RBI will have to stay vigilant about the sequencing of tapering, rate increases and balance sheet shrinkages by the systemically important global central banks as that will bring with itself a high likelihood of a significant correction for local stock markets and other risky asset prices.

The RBI will not be in a position to return to its mandate of “price stability" until the economic situation normalises. In the interim, it will encourage lenders and borrowers to prepare for tighter external financial conditions by lengthening debt maturities wherever possible and limiting their exposure to un-hedged foreign currency debt.

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