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Seventeenth EGROW Shadow Monetary Policy Committee Meet held on August 3, 2021


Recording of the event

Key Takeaways

  1. The overall GDP FY22 is expected to be 10% -/+ 1%, with downside risk higher because of the second wave.
  2. Inflation likely to remain elevated around 6 per cent.
  3. Nationwide third wave is highly unlikely unless there is a new mutation.
  4. Construction intensive infrastructure will pick up soon to stimulate private investment
  5. Policy interest rate retained in US, UK, Euro but raised in Russia, Brazil.
  6. Rural sector not as insulated as in the first wave.
  7. The gross NPAs could increase in the next few months.
  8. Need to be alert to capacity destruction & capital depletion in informal sector.

Recommendation of EGROW Shadow MPC

Members of EGROW SMPC - 4
Repo Rate - Retain at 4 percent - 4 members

Non Members – 3
Repo Rate- Retain at 4 percent – 3

Detailed Views by Members of the EGROW Shadow MPC

1. Dr. Arvind Virmani, Chairman, EGROW Foundation

Introductory remarks

More than a year ago, EGROW research paper discussed the economics of lockdown[1] and the transition to normalcy. The transition played out as we had envisaged and normalisation had occurred by March 2021 as anticipated.

Second Covid wave started in April and we were back into another transition period, characterised by regional, better targeted restrictions in terms of services and selected district lockdowns. In the last meeting we had pointed that public forecasts were following the covid waves, but our analysis of the second wave allowed us to see through it.

The available forecasts were much too affected by short term developments resulting in a high correlation between covid cycle and GDP forecasting cycle. Our analysis of the delta variant, in EGROW foundation research paper, clearly showed that the new variant is not part of the old wave which is more or less over. Based on our dual S-curve model, we predicted that the covid variant would spread very rapidly and then decline just as rapidly as it grew. This is what happened by end of July.

The key point to note is that people were focussing on the wrong issue. It was not the incompetence of the government or the carelessness of the public which was critical in the second wave, but the high transmissibility and severity of the new variant(s). This has been proved by the spread of the Delta variant in the UK, Indonesia, other SE Asian countries, US and China.

Based on the second wave model, published in May 2021[2], we had concluded that FY22, Q1 GDP would be much worse than predicted by anyone and Q2 GDP would bounce back much faster that anyone was expecting. Consequently, Q2 GDP would make-up most, but not all of the losses during Q1. With H2 growth recovery still on track, the full year growth would remain within our six month earlier forecast of 10% +/- 1 percent, with a downside risk. That is how the economic recovery has played out so far.

In our 2020 paper on fiscal policy during the transition[3] emphasis was on logistics disruptions, and supply chain disruptions during the transition period. Logistics problems were much severe in other parts of the world than India. There were problems of sudden stops and sudden starts. The logistic costs of Indian exports went up by only 20 percent, compared to the logistic cost of exports from China to the US, which went up by 100 percent or more.

In the USA this was aggravated by a shift in demand, from services to goods. Demand for manufactured products and imports of the same shot up. This resulted in unexpected pressure on logistic chain. The logistics of delivering commodities are completely different from services and there was a shortage of ships and containers, and those costs went up. As covid wave dies down, we will see a reverse shift, the demand will shift back to services. Disruptions in the supply chain are an important factor to keep in mind. Eg. semiconductor disruptions, the natural resource commodity disruptions, etc.

As our analysis indicated, inflationary pressures from logistics and supply chain disruptions would have a large temporary component in India, USA and worldwide, because of its origin in the supply chain disruptions. However in the case of India inflation is also strongly affected by global petroleum oil and edible oil prices, both of which have increased substantially during the last six months.

Macroeconomics of Indian economy: Exports, Investment and private consumption

There has been a surge in exports from India especially in the Q1 and till July. The macroeconomic issue is to determine how much of this is temporary and permanent. There have been many indications in the data and personal observations that supply chain shifts are occurring. Most of the surge seems to be due to the shift in supply chains. This has two elements- incremental demand and diversification and risk reduction. There is increasing willingness to pay 10-20 percent higher cost of imports from India, to reduce China risk. This willingness is increasing with the unpredictable behaviour of Chinese authorities, ranging from random actions with respect to capital markets and tech companies and severe lockdowns in many cities purportedly based on a few Covid Delta cases numbering in the tens.

The government must make sure, with the help of industry associations, that any new bottlenecks are identified and solved expeditiously, to ensure that this great opportunity is translated into permanent increase in World export shares.

The government’s provision for Capital expenditure was increased by 30-34 percent in the budget. This will finance construction intensive infrastructure in FY22. The momentum was somewhat disrupted by the second wave but will pick up in Q2 FY22 and stimulate complementary private investment. We expect the Digital economy to lead private investment during FY22. However, much of this investment comes under intangibles and will not be visible in the usual indicators of fixed investment.

Doubts remain about the speed of recovery of private investments because of the depletion of private saving/increase in indebtedness of those affected by Covid infections and those with employment/income losses during lockdowns. EGROW’s research paper in 2020 had pointed to the importance of distinguishing between Contact Services, goods and their related services, and non-contact services. The key new element is the dynamics of the shift in relative demand for goods and services. The shift from savings to goods consumption took place during the lockdown and transition period was when fears of contagion were high. As vaccination drives proceed and fears of Covid contagion subside, there will be a gradual shift back to services and a reduction in the pressure on the demand for goods. This will translate into reduced pressure on logistics chain, logistics costs and inflationary pressure on commodities.

In India, a nationwide third wave is highly unlikely unless there is a new mutation similar to the delta variant. But, regional variations in the number of cases will be observed.

The overall GDP is expected to be 10% -/+ 1 percent, with downside risk higher because of the second wave. Though the second wave is over on a nation-wide level, we may continue to see regional flare ups as have happened in Kerala, Maharashtra and the Northeast. However, given the learnings from the first two waves (Govt, business, public), the increase in sero-positivity (2/3rd of population) and the higher vaccination levels (1/3 of adults), a nationwide third wave can only happen if there is new Covid variant comparable in transmissibility and severity as the delta variant. Nobody can predict this, but the medical community can ensure that any such variant is detected quickly and contained before it becomes another wave!

The interest rate should, and is likely to, remain unchanged. So too the future guidance on monetary policy.

Capital depletion, capacity destruction!

The government and RBI must be alert to any, “Capacity destruction” and “capital depletion in informal enterprises” that has taken place under the radar of regular data collection. The formal sector, particularly the corporate sector is flush with cash and have reduced their demand for credit. The medium-large firms in the MSME sector will also have sufficient access to credit once their demand revives. My concern is for the self-employed and the micro & small enterprises which have exhausted their personal and family sources of working capital and may have difficulty obtaining the capital needed to restart their enterprises. The government and RBI must be on the look-out out for sectors/industries/services where capital depletion has happened and ensure that help is provided for restarting their business.

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

The high frequency economic data continues to improve, signalling that the worst remains behind. Notably, MPC’s June statement and the minutes both had highlighted the upside risks to inflation, with adequate reference to the need for the government to take measures to the supply side inflation. However, we haven’t seen much traction on that front which continues to keep upside risks to inflation intact. Infact the mild hawkishness in the previous minutes came even before the two inflation readings above 6%. Clearly the challenge for the MPC will be to maintain the fine balance.

In the upcoming policy I expect a status quo on rates and stance but see possibility of a hawkish tone of the statement given the increasing risks to inflation. Even if the MPC was to emphasis on the transient nature of inflation, the inflation outlook trajectory will need to be revised up by 30-50bps. Meanwhile the growth forecast of 9.5% may be only marginally tweaked accounting for the upside to their 1QFY22 projections (RBI’s recent Bulletin provides an estimate for 1QFY22 GDP of 22.1% compared to 18.5% mentioned in the June policy). While the divergence in views and the related discussion of policy normalisation will become clearer in the minutes of the meeting, the guidance in the policy statement will be crucial. Beyond August, we expect the onset of gradual monetary policy normalization, with liquidity management tools to be used at the fore in order to reset the floor rate slowly within the policy corridor. Tools like overnight VRR, increase in quantum of 14-day VRR and allowing non-bank participation in the VRR could be the playbook before a reverse repo hike in December. Policy recommendation and expectation: Status quo on rates and stance

3. Mr. Abheek Barua, Chief Economist and Executive Vice President, HDFC

Clear sequential recovery captured in a number of indicators. Rural segment also showing signs of traction, shortfall in kharif sowing declining and monsoons get evenly distributed. However weekly activity indicators have shown considerable volatility in the past and Need to watch this trend in future.

The broad message from companies, fund managers and other stakeholders is that of an uneven recovery with the large formal sector and middle-class salaried households recovering well; Small business, informal sector not recovering as quickly and access to funds following a similar pattern because of risk perception except credit guarantee beneficiaries.

Rural sector not as insulated as in the first wave. FMCG surveys shows Tier-II cities have led the push. Household budget strain reflected in PF drawdown, loans against gold, default on loans against gold. Government spending has been weak. Some sign of pick-up in July. Need spending to pick-up to help growth momentum and premature fiscal consolidation a risk.

State governments face multiple problems including pandemic-related expenditure and financing uncertainty, large expansionary push unlikely from them, third wave risk critical for private sector.

Loose monetary policy seems to be working largely through disintermediation, CP issuance in July at 27-month high, and some uncertainty about exports with delta wave affecting major buyers and China slowdown the biggest risk.

Inflation likely to remain elevated and in the 6 per cent neighbourhood with relief in September and October, March forecast 5.7 per cent. GDP growth forecast at 9.1 per cent for the year, relief from commodity price cool down including high oil prices. However inflation likely to have frictional components, High pump prices for petrol and diesel having diffusion effects.

RBI has done some mild implicit tightening by letting benchmark yields move up. Start conversation on future liquidity normalization however making any reduction contingent on emerging situation. Keep monetary policy accommodative with no rate changes. Guidance should be towards more accommodation.

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

Indian Economy also needs to be seen in the context of global events. The IMF assessment has estimated growth rate at 4.9 percent for 2021. It has predicted the growth rate for emerging countries to decline and the growth rate for advanced countries to increase.

In the last few months, policy interest rate has been retained by the US, the UK and the Euro. Russia and Brazil have raised their interest rates.

The growth projection for India, by the IMF, has been reduced to 9.5 percent for 2021 which is a sharp reduction of 3 percent from the April estimates. IMF says the community prices have been rising which will have an impact on the global economy. The prices of petroleum goods in July 2021, over December 2020 have increased by 30 percent. This has an implication globally on the price level though not permanently. However, the view expressed by the IMF is that this transitory rise in inflation should not be seen as a long-term trend and that the Central Banks should not raise their interest rates just for inflation.

The domestic scene is different. In the country, the monsoon is progressing fairly on track, implying that agriculture sector is well poised for sustaining growth. However, the banking scene is concerning. The credit off-take is lower whereas deposits have been increasing at a rapid rate. Banks are flushed with resources. In the credit off-take, the share of industry, especially private corporate sector in total credit has declined while for retail loans, an increase is noted. The share of personal loans and housing sector is rising significantly.

The delinquency rates which have been published by the RBI in its latest Financial Stability Report show that there is an increase compared to March 2020 in case of NBFCs/HFCs and private banks. This is a matter of concern. The expected third wave of COVID, because vaccination is still not complete, can lead to further lockdown and slowdown in economy. The balance sheet of corporate sector starts reflecting on the balance sheets of commercial banks. So, in the next few months, it is a matter of concern that the balance sheet of commercial banks may record higher volumes of NPAs despite the fact that commercial banks are making adequate provisioning.

The other indicators in the economy are robust. The Index of Industrial Production (IIP) is another indicator of industrial performance and the latest data for May 2021 shows that all industries are recording significant growth, especially capital goods and manufacturing. Similarly, if the eight core industries are observed, same trend is noted and growth is picking up, especially in steel.

The CPI is at around 6 percent, mainly on account of oil, fats, fruits and pulses. The expectation survey done by IIM Ahmedabad shows that the inflation expectation one year ahead continues to be less than 6 percent. The WPI is in the range of 10-12 percent but, the increase in oil prices and the price of manufactured goods are the factors which have lead to higher inflation under WPI. Therefore, it can be concluded that the increased inflation is transitory and the RBI should not increase the policy rate s has been done by Russia and Brazil. Rather, India should follow the pattern of US, UK and the Euro and retain status quo.

To conclude, the RBI should continue with its accommodative monetary policy and not change the policy rate.

Guest Panellists

Special Guest

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

I do not expect any change in the policy rate in this particular round of MPC meeting. The policy rate will not change anytime soon in this calendar year. No change in the accommodative stance. A 6-0 voting is our baseline scenario for this particular policy for this year.

Our forecasts of inflation and growth rate which is relatively more conservative compared to the market consensus. About rural development side we sense that the situation seem to be a lot better compared to last time. The effects of pandemic on the economy are definitely worse on the rural side compared to how it was a year back.

When it is a more steady state movement for the overall economy, the rural growth picture is within a much narrower band compared to the urban segment. But, when there are some disruptions in the form of physical movement of goods and services, the volatility component goes up dramatically. The mobility restrictions vary across the regions of the country.

We think going ahead, on a PNL basis, over the course of next few months we will see continuous improvement assuming there is no strong third wave and more prolonged lockdowns.

In terms of balance sheet, overall financial health has taken a significant beating in several pockets of rural India because of natural calamities especially for the past two years they have been facing big dents in terms of not having income, getting into debt, etc.

The expectation regarding the agriculture income still seems to be relatively better onto which people in rural areas need to cling on. A lot will depend on the next 6 months, though there is gradual improvement in overall activity, it will take a while to overcome the hit.

In terms of the last RBI policy, the professional forecast survey, the GDP forecast was approximately 9.8% with the minimum forecast being 7.7%.

Consumption is languishing less than 50 in the latest RBI survey. Two thirds of the economy will be moving at a relatively slow pace. Uncertainty is going down and the GDP growth will be around 8% this year. Inflation will be around 6% by and large.

Guest from ASSOCHAM

2. Shri Shachindra Nath, Executive Chairman & MD, U GRO Capital

RBI Monitory Policy should create a systemic liquidity window for NBFC focused on lending for priority sector. Inclusion of NBFC in TLTRO did not yield much desired result and a direct liquidity facility is needed to provide impetus to the credit supply for the credit starved priority sectors of India.

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

I am in favour of status quo about interest rate and accommodative stance till this financial year. RBI should do more in terms of liquidity providing to small and medium NBFC for onward lending. I am also in favour of more tranche of G-saps and OMO so that Government securities yield should not rise.