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Nineteenth EGROW Shadow Monetary Policy Committee Meet held on December 2, 2021


Recording of the event

Key Takeaways

  1. Indian economy is on path to achieve double digit GDP growth in FY22
  2. Q2 GDP data and IIP suggest that recovery level is strong
  3. Robust GST collection of Rs.1,30,000 crore in November is healthy sign
  4. India’s merchants' exports are performing well.
  5. India's focus for the medium term would be to reiterate jobs and trade
  6. Inflationary pressures are persisting
  7. Build up of reserves helps to stabilize INR
  8. Omicron has raised downside risk to global GDP.

Recommendation of EGROW Shadow MPC

Members of EGROW - 4
Repo rate retain at 4 per cent - 4
Accommodative should continue- 3
Accommodative to neutral - 1

Non Members – 3
Repo rate retain at 4 per cent
Stance: Accommodative should continue

Detailed Views by Members of the EGROW Shadow MPC

1. Dr. Arvind Virmani, Chairman, EGROW Foundation

Recording of macro overview and inputs

Indian Economy is on track in FY2021 to achieve the GDP growth we had projected about a year ago, reiterated in early 2021, re-evaluated after studying the second wave, ie 10% -/+ 1% with downward bias. Prior to the Omicron variant we had narrowed the forecast uncertainty to +/- 0.5%, but the arrival of the new variant returns the uncertainty band back to 1%, with downward bias.

Q2 GDP data and IIP suggest that recovery to FY2019 levels is stronger in fixed investment than in private consumption. Within private consumption non-durables a re close to 2019 levels is below 2019 levels. The trade deficit has expanded due to sharp recovery in gold imports, oil prices despite high export growth. The latter will slow because of slower global demand, but India’s growth will continue due to supply chain diversification. The impact on trade deficit will be limited due to oil price moderation.

Almost 18 months ago we had pointed to the simultaneous existence of excess demand and inflation pressures some commodities and geographies and excess supply and deflation in others during the transition from pandemic to normalcy. The extended transition due to repeated COVID waves in USA and lockdowns China was however not anticipated. The interaction of these factors with the large stimulus in USA has disrupted logistics much more than was anticipated a year ago. However, the localized imbalances within India and to lesser extent within Europe have played out more in line with our analysis.

The structural reforms undertaken by Govt. since September 2019 were projected by us to put India on a fast growth track by FY22, with a forecast growth rate of 7.5% +/- 0.5% (7% to 8%). This is being increasingly recognized private analysts, with the two-year GDP growth rate rising to our projection of 17.5%, though their pattern of growth in each year differs. There has also been speculation on the effect of repeal of new form laws on other reforms. With 45% of workers associate in some way with agriculture, farmers are the biggest political interest group. The next largest political interest group, organized labor, is less than 8% of workforce, while other interest groups are a fraction of 1% of work force. Therefore the effect on other reforms will be minimal. That said, it is wise to time and phase reforms carefully to minimize economic & social disruption.

Recovery of the informal, non-agricultural sector of the economy seems to be lagging. Though there is a paucity of specific data, there are indicators- The slow recovery in private consumption and the low level of consumer confidence (as shown in the RBI’s CCS) and another indicator is the declining trend in rural non-agricultural to agricultural wage, indicating slow growth of income.

Though part of this is temporary and will recover with the recovery of Contact services like retail trade, hotels, restaurants, tourism and hospitality, some may contribute to the trend decline in share of informal sector. The share of informal sector in India’s economy is too high relative to its per capita GDP is too high and must decline as formalization accelerates. However, it is essential that any socio-economic disruption and ensure that modern MSMEs have a level playing field relative to corporates (domestic & foreign).

The forthcoming Budget must focus on the tax reforms & rules needed to ensure a reduction in cost of doing business by MSMEs, which generate the majority of new jobs. This requires reform and simplification of the Direct tax code, GST and Import tariffs/duties.

Direct Tax Code (DTC): A published draft of a simple, rational, incorporating global best practice was approved at the last formal meeting I attended as CEA in October 2009. A committee appointed by current govt. has thoroughly reviewed and debated its provisions and given its report. Only legislative action is pending. This is critical to lower the CODB for MSMEs on par with companies subject to corporate law, which was reformed in September 2019.

Import Duties: The dispersion of import tariffs is too high, for instance in textiles where there are dozens of specific rates. These distort incentives from efficient protection and export to evasion through misclassification and excessive imports. The average tariff rate also increased from 13.8% in 2018 o 17.6% in 2019. These rates have already been reduced to 15% in 2020, but need to be reduced further to 12.5 to 13.5%. This will boost exports of labor-intensive goods and facilitate integration with MNC supply chains through which a majority of World exports occur.

GST: A dramatic simplification of GST, with 3/4th of goods & services having a single, uniform rate of 15% and no cess, without worrying about a decline in revenues in first year will provide a boost to consumption and MSMEs, and raise revenue buoyancy. Exemptions should be limited to basic food, basic education and basic health services & drugs. To ensure revenue neutrality in second year, a higher 25% rate and cess, should be levied only on the automobile sector, tobacco products& beetle nuts.

The Omicron variant of COVID, has again raised the downside risk to global GDP, and indirectly through demand for our exports and FDI in supply chain diversification. Once this risk is resolved, monetary policy stance should be restored from accommodative to neutral. This is likely to take another month or two, so monetary policy is likely to remain unchanged at the next meeting of MPC.

2. Shri Indranil Sen Gupta, Head of Research, CLSA, India

We expect the RBI MPC to retain an accommodative stance and continue to pause on rates. We expect the RBI to go on trying to suck out domestic liquidity. The Covid 19 shock has solved two problems, by cutting down high real lending rates and building up FX reserves to stabilize the INR. It, however, has created a demand problem that will require lending rates to remain soft for longer.

3. Ms. Upasna Bhardwaj, Senior Vice President, Kotak Mahindra Bank

The growth momentum, even though uneven, has been gaining traction. At the same time, inflationary pressures too have been elevated and have been more persistent than earlier perceived. We expect RBI to revise up the inflation trajectory given the persistent supply side constraints and the pass through of higher input prices. Meanwhile, we expect RBI to retain the growth projection at 9.5% given the recent uncertainty arising from the new Omicron variant. We expect the MPC to continue to undertake liquidity normalisation measures to manage rates for now while keeping policy rates unchanged. However, we expect the guidance to be tilted towards hawkishness to prepare markets for policy corridor normalisation in the next policy.

4. Dr. Charan Singh, CEO and Director, EGROW Foundation

The GDP projections given for the current financial year and the next show robust growth for India, but it is to be considered that is on low base of the previous year. The IMF estimates that India will grow 9.5 percent in 2021 and 8.5 percent in 2022. Other estimates by different agencies also converge around this number. Thus, India will be the fastest growing economy of the world.

The latest data on GVA, released recently for July to September 2021is encouraging but could have been better. The latest trends in industrial production, including core industries, are mixed, especially in September 2021 and therefore recovery has to be carefully interpreted. Private consumption expenditure and that of the Government is lower than previous quarters. The high frequency data also a mixed trend: sale of commercial vehicles is higher in Quarter 2 of current year compared with previous year while purchase of private vehicles is lower.

The Consumer Food Price Index in October 2021 was lower than that in the previous year for general and food for Rural, Urban and Combined, respectively. In October 2021, the worst hit commodities were Oil & Fats (33.50 percent), Fuel and Light (14.35 percent) and Transport (10.90 percent). The concerns are the wide variation in CPI among states - Odisha (1.78 percent), Bihar (2.24 percent), Jharkhand (2.68 percent), which were low as compared to Himachal Pradesh (6.14 percent), Delhi (6.15 percent), Telangana (6.60 percent) and Jammu and Kashmir (6.97 percent).

The Wholesale Price Index (WPI) has increased from October 2020 to October 2021 where at present the WPI for all commodities is high at 12.54 percent, Fuel & Power at 37.18 percent, and Manufactured Products at 12.04 percent. The food price index is comfortable at 3.06 percent.

The GNPAs were estimated to be 7.48 percent in March 2021. In March 2022, the NPAs are expected to be 9.80 percent in case of baseline scenario and 11.22 percent in March 2022 in severe shock scenario. However, the stress levels are certainly lower than the previous years and banks are buffered well with reserves.

Sectoral Deployment of Bank Credit is also good with credit to agriculture and allied activities performing well and having a growth of 10.2 percent in October 2021 as compared to 7.2 percent in October 2020. Credit growth to industry picked up to 4.1 percent in October 2021 from a contraction of 0.7 percent in October 2020. Medium industries saw a growth of 48.6 percent in October 2021 as compared to 20.8 percent last year.

Retail and MSME segments form 40 percent of bank credit. They are expected to see higher accretion of NPAs and stressed assets this time.

The spill-overs are important in the well-integrated global economy. In this context, monetary policies could be following different trajectories as inflation is behaving differently in different countries. Inflation is high in the UK, USA, amongst advanced countries and in Turkey, Russia and Brazil amongst emerging economies. The US Fed continues with the same rate but correction can be expected soon amidst fear of stagflation. The Bank of England continues with its same rate of 0.1 percent. The Eurozone too is continuing with its previous rate as well as Australia where the inflation us around 2.3 percent. Russian Federation has raised its Bank Rate to 7.5 percent and inflation is around 7.4 to 7.9 percent. Brazil has raised its Selic Rate to 7.75 percent and Inflation is around 9 percent.

Gold prices are projected to surge to Rs. 52,000- Rs. 53,000 over the next 12 months. The DD for Gold jumped to 47 percent in YoY to 139.1 tonnes in July-Sept. 2021 as compared to 94.6 tonnes a year ago. Oil prices are projected to be at $72 per barrel from the current level of $82 per barrel, as production is expected to outpace demand.

In the case of monetary policy, a few specific points need consideration. First, the increasing income inequalities due to Covid need to be addressed. While fiscal policy will have an important role to play, monetary policy would be required to support the process. The stress in the economy will reflect on the balance sheet of the banks. Second, there have been concerns about the climate change and this has an impact on production process in the economy, especially agriculture. The monetary policy is in charge of micro and macro prudential norms. Therefore, may be, the RBI should consider sustainable/green stress tests on the banks and conceive financial schemes that help address the issues of income inequalities and greener economy.

Financial inclusion has been stressed in literature on income inequalities and in India, many new accounts have been opened under the Jan Dhan Yojana. The RBI should now consider expanding the coverage of accounts to MSMEs, which are mostly unregistered. In a recent webinar hosted by the EGROW Foundation on Nov 26, 2021 with participants from the MSME sector, it emerged that there is difference between the government and the Reserve Bank on the subject of MSMEs.

The new Covid variant, Omicron variant has increased uncertainty in the global markets and there are fears that the economies may not be able to stage recovery until 2023 and may be even the year 2024 would also be impacted. In view of the above analysis, it would be appropriate if the RBI maintains an accommodative stance and does not venture to change the Repo rate too.

Guest Panelists – Specialists from Market

1. Shri Siddhartha Sanyal, Chief Economist & Head- Research, Bandhan Bank

India's broad macro numbers continue to strengthen. However, recovery in the economy remains uneven and still only at a nascent stage, while inflation concerns driven by supply side disruptions get stronger. Corporate profitability was strong in recent quarters; but, may not enjoy strong tailwinds in the coming months amid rising cost pressures.

One expects the MPC's reaction to stay nuanced in the December meeting. Withdrawal of crisis time liquidity has very clearly started and will likely be stepped up further, while rates look set to be on hold in December. In the coming months, the MPC will likely consider narrowing the repo reverse repo rate corridor by gradually raising the latter and change the stance of monetary policy to neutral from the current accommodative stance. However, the final step in normalizing monetary policy - that is hiking the repo rate - is unlikely to be considered before mid-2022.

2. Shri Arjun G Nagarajan, Chief Economist, Sundaram Mutual

The RBI's monetary policy is most likely to see a pause on both rates with a reiteration of its accommodative policy stance on two counts. Firstly, the RBI would not want to pre-empt the Fed policy that would be announced in just over a week after the RBI policy. Secondly, the recent Omicron variant has created an additional layer of uncertainty that the RBI would not want to overlook. Further, the best time to look at reverse repo rate normalization would be post the budget with early FY23 better placed to start normalization when most of the key events would be out of the way, like the Fed view, Omicron and India's budget math.

It would take another week to get a much clearer sense on the disruptive nature of the Omicron variant. While infections in South Africa's Gauteng province and South Africa as a whole are on the rise exponentially, the hospitalizations’ curve appears to be well below what it was during its Delta wave. Further, one cannot draw conclusions from South Africa's experience into Europe because of the age-demographics that are very dissimilar. For e.g. while South Africa has 65Y+ population of 6%, in Italy for example, it is north of 23%.

India's focus for the medium term would be to reiterate jobs (construction and education) and trade (improves competitiveness and market share). Skilling and focus on increasing education for the girl child and gaining share of women in the labor force remain key aspects to focus on.

Guest from ASSOCHAM

1. Shri S. C. Aggarwal, Senior Member, ASSOCHAM & CMD, SMC Group

RBI may remain less accommodative as the economy is in a much better safe and slowly moving back to pre-covid levels of economic activities. RBI has pumped Rs. 13.6 Lakhs Crore of excess liquidity since March 2020 through its various measures. As per the MPC committee members feeling there is ample liquidity in the system and that excessively high surplus must be reversed to some extent.

In a monthly bulletin published in November 2021 by RBI said domestically there have been several positives in the covid-19 front in terms of reduced infection and faster vaccinations. Mobility is rapidly improving, Job market is recouping and overall economic activity is on the cusp of strengthening revival.

Some economic indicators:

  • Robust GST collection in November around 1,30,000 crores
  • India’s manufacturing sector gains further strength in November on strong rise in production and sales
  • The seasonally adjusted IHS Markit India manufacturing (PMI) increased from 55.9 in October to 57.6 in November
  • India’s merchants exports rise 26% in November, 2021 to 29.88 Billion Dollar in comparison to November, 2020 at 23.6 Billion US Dollar
  • GDP grows at 8.4% in Quarter 2 F.Y. 2022 giving an indication of double digit growth for the full year.

Companies gear up for new virus Omnicorn version of Coronavirus vaccine.

Goldman Sach has forecasted headline CPI inflation to increase to 5.8% (year of year average) in 2022 from 5.2% in 2021. Strong fiscal and monetary support alongwith a rapid improvement in the pace of vaccination has helped nurture a swift economic recovery. We expect repo rate and reverse repo rate hike of 50 basis point by the end of FY 2022.