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Sixteenth EGROW Shadow Monetary Policy Committee Meet held on June 1, 2021


Recording of the event

Key Takeaways

  1. Extreme uncertainty in domestic and global markets making projections and policy is a challenging task
  2. In comparison with global scenario, India’s economic performance is not bad.
  3. Moderate downward revision to growth for FY22 in view of the 2nd wave impact and 3rd expected.
  4. MSME and MFI sector have been severely impacted by the 2nd wave.
  5. Urban unemployment at around 18 percent is worrisome.
  6. Continue with unchanged Repo rate and accommodative monetary policy.
  7. Supply chain disruption and its impact should be considered.
  8. Need for fiscal reforms, further simplification of GST.
  9. Need to announce a more aggressive GSAP 2.0 to avoid disruptions.

Recommendation of EGROW Shadow MPC

Members of EGROW SMPC - 4
Stance - Accommodative - 4 members
Repo Rate - Retain at 4 percent - 3 members
Reduce by 25 bp- 1 member

Non Members – 4
Stance - Accommodative - 4
Repo Rate- Retain - 4

Detailed Views by Members of the EGROW Shadow MPC

1. Dr. Arvind Virmani, Chairman, EGROW Foundation

It is useful to compare India's second wave with the first wave, in analysing its effect on the Indian economy. However, this analysis is incomplete, unless there is a better understanding of the speed and severity of the 2nd wave relative to the first. It also requires an understanding of Pandemic and lock-down economics.

Comparing both the lockdowns, essential goods was exempted in both the cases. Therefore, it is unlikely for agriculture sector to be affected due to the lockdowns in states. There are two exogenous. This time around, the global & Indian agricultural prices are much higher than the previous year. This will tend to have a positive effect on agriculture sector despite increase in input prices, as terms of trade are clearly better. The second factor is the rise in real wages. Both these factors are positive for the rural economic in FY22.

Conventional wisdom is that the Covid 2nd wave would follow the same pattern as the first wave. But recent analysis have shown that the second wave was faster and much more virulent in terms of numbers of cases and deaths, and will therefore subside much more sharply and quickly than the first wave. Hence, there may be an upside surprise to the economy and we can conclude that agriculture will do better than in 1st wave, after an initial hiccup.

Talking about unemployment, in the first wave, unemployment rose to 8.8% in March, 23.5% in April & May and started improving to 11.6% in June as the lockdown was eased. In case of the 2nd wave, unemployment rate rose from 6.5% in March to 8% in April and further to 11.8%. This was half of first wave peak. So the direct effect of lockdown on production is about half of first wave as well. The ratio of the urban to rural unemployment rate in the second wave is 1.4 compared to 1.1 in the first wave. This shows that urban areas have been hit harder than rural areas contrary to the assumption of most analysts. This is to be expected from our research on the State wise spread of the mutated virus causing the second wave, which showed that states with higher urbanization have been worse affected than less urbanized states. Due to the high deadly impact of the second wave, pre-existing shortages of skilled labor will be accentuated, which will further negatively affect the speed of recovery of industry & services for which demand recovery is quick. Government should quickly implement the changes in the Apprentice ship act announced in budget, and to improve training of semi-skilled workers in cooperation with industry.

Contact services (hospitality, entertainment, tourism) would take much longer to recover, because of the reality and the fears of infection, particularly in indoor venues and badly ventilated locations. Government needs to incentivize improved ventilation in outdoor venues as well as indoor public spaces & factories & offices, installation of high-quality air filters in air-conditioned halls & buildings and Ultra-Violet (UV) ceiling lights in crowded, small rooms (pubs, bathrooms, kitchens, and restraints).

The precautionary savings of household are expected by many analysts to increase, post second wave, and thus delay the recovery of private consumption. There are however three other factors one negative and two positive that need to be considered to derive the net effect on consumption. The consumer confidence incidence (RBI survey) fell from 86 in March 2020 to a low of 50 in September 2020 and had recovered to 55.5 by Jan 2021 & declined to 53.1 in March 2021. This will be a negative factor in the speed of recovery of private consumption after lockdown. Interestingly, the gap between the current and future expectations index has more than doubled since pre-covid days and may result in a fast reversion in current expectations, once it starts. Institutions providing consumer credit (e.g. NBFCs) are in a much healthier position than they were 18 months ago, while credit demand from corporations for bank credit is low, given higher internal savings. So, consumer credit will aid recovery. There was no vaccination in sight through much of the first wave. There are now several approved vaccines, including two produced in India, with several more on the way. The planning & management problems which have slowed vaccination are manageable and will be solved. So, the medium-term income growth trend is much more positive than during the first wave. Both these factors will offset the desire for more precautionary savings.

As our research had predicted, post lockdown, the Manufacturing-Mining-Construction sectors recovered rapidly after supply chains disruptions were addressed. Given the geographically and sector-ally more limited nature of the current lockdown, supply chain disruptions will be more limited in India, and with the recent experience of already dealing with them, the recovery will be rapid. Supply chain disruptions are more widespread across the world. This will increase the oil prices, which will have a negative effect on the national income & growth. But as usual this impact will be partly offset by higher exports and remittances. Therefore, we can clearly state that the supply chain disruptions and short-term adjustments in demand (e.g. diversion of demand from contact services to goods, because of contagion fears) will lead to inflationary pressures in particular goods or sets of goods. But these pressures are temporary and will subside as COVID contagion fears decline and demand patterns normalize in 2021

Giving an economic overview, the overall, GDP growth in Q1 of FY22 will be lower than projected in March 2021, and investment revival delayed by one quarter. As consumption depends on expected income, which is clearly on an upward trajectory in H1 of FY22 as against the downward trajectory in H1 of FY21, this factor will offset the impulse to increased precautionary savings, from Q2 of FY22. Recovery will be much faster in Q2 than anticipated by forecasters. FY 2022 GDP growth will remain within the range of 10% +/- 1.5%, even though the downside risk appears much higher at this point, than it was in February 2021.

Fiscal deficits are being driven by GDP linked revenue fluctuations, which act as automatic stabilizers. The best fiscal stimulus that Government can provide is revenue neutral or revenue negative tax reform, by accelerating simplification of GST towards a single rate (15%) for 75% of G&S, introducing a new direct code. Speedy revival of construction intensive infrastructure projects will help normalization of total employment. Incentives for air filters & UV lights and investment/production/distribution of COVID vaccines, will help reduce the chances of a third wave, reduce fears of contagion and restore consumer confidence.

Government can speed the recovery, by implementing the apprenticeship act reform announced in budget and completing Ease of compliance of Labor, tax & financial laws & rules, which it has previously promised. Central govt should also review the laws, rules and regulations affecting start-ups and tech companies to make them competitive with other locations like Singapore. State governments must do their part in simplifying the jungle of controls and regulations imposed by them, and speeding up the vaccination process. Monetary policy is and has been on the right trajectory since the start of the pandemic and should continue the same path. Only fine-tuning of credit policy or government security markets may be needed.

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

I expect The high frequency data suggests that economic activity has taken a hit since April with May likely to have been the trough as states re-imposed lockdowns. The extent of moderation has been significantly lesser than last year’s lockdowns but uncertainties remain abound both in terms of supply and demand side constraints. Most states’ have extended the restrictions into mid-June thereby postponing the economic revival into the next quarter. Unlike last year’s revival in activity which was led by pent up demand, we remain cautious on the consumer demand going ahead as precautionary saving may remain high given the looming risk of a third wave as vaccination pace is only gradually picking up. We have revised down our FY2022 GDP growth estimate to 9% from 10% earlier, but given the uncertainties we expect GDP could be in 8-10% range. We expect a gradual improvement in the manufacturing sector from June onwards even as contact-based services sector recovery is expected to be drawn out.

While growth risks are seemingly skewed on the downside, inflation does pose upside risks. The double digit WPI inflation has witnessed a reasonable pass-through of the global surge in commodity prices. However, the retail inflation still remains relatively in check. Given the construct of the CPI inflation, we see limited pass-through from WPI to CPI in the near term. CPI inflation is thus expected to remain within MPC’s upper band of inflation target (6%). This should provide comfort to the MPC to continue to prioritize growth and retain its accommodative actions in the upcoming policy. Incrementally, however, MPC’s scope to further easing seems limited to accommodating the fiscal expansion. Given the recent concerns in the bond market from possible fiscal slippage and excess supply arising from a shortfall in GST compensation cess collections the RBI will need to announce a more aggressive GSAP 2.0 to avoid disruptions.

Overall, I see policy rates and stance unchanged until 1HFY22. Beyond that any policy normalization will remain a function of growth pickup, vaccination pace and materializing of impending inflation risks.

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

The RBI used emergency measures in the first COVID wave in 2020. This included a deep cut in the policy rate, massive infusion of liquidity both through bond purchases and a cut in the Currency Reserve Ratio to ensure that banks had enough funds to lend and at low rates. Targeted Long Term Repo Operations were geared towards delivering credit to the segments of the economy that were hurt the most. Moratoria were granted across the board to borrowers and were later followed by a comprehensive restructuring plan for company loans. Large credit institutions like NABARD and SIDBI received direct liquidity support. The government also lent a helping hand in unclogging the credit sluices. Credit for MSMEs backed by government guarantees (the ECLGS) was a measure that was clearly successful.

It is unlikely that the RBI can deviate much from this in handling the current crisis that is riding on the second wave. However, it must recognize the specific features of the second wave that make things different from the first and fine-tune its measures. For one thing, the extent of penetration of the virus into the rural areas has been much higher than the first. The likely damage to rural incomes would mean that small institutions such as Micro Finance Institutions and smaller NBFCs are likely to face major problems.

Besides, there is a raft of anecdotal evidence that sickness in the workforce has caused much greater disruption in labour supply. The current strain of the virus also seems to be more debilitating for its victims. Large firms might have the buffers and facilities to handle this better. Small and medium firms could be crippled by this and need funds to tide over forced shutdowns.

Some emergency measures announced on the 5th of May recognized these problems. Special three-year long-term repo operations (SLTRO) of ₹10,000 crore at repo rate for Small Finance Banks (SFBs), were announced for fresh lending of up to ₹10 lakh per borrower. (SFBs) have been played a key role in the “last mile supply of credit to individuals and small businesses.” SFBs were also permitted to classify fresh lending to smaller MFIs (with asset size of up to ₹500 crore) for on-lending to individual borrowers as priority sector lending.

However, there are problems. Of the first tranche of these special LTROs conducted on May 17 for SFBs, only Rs 400 crore was borrowed. This reluctance could perhaps be explained risk-aversion. SFBs might be able to borrow from the RBI at low rates but might be squeamish about lending fearing a rise in bad loans. The only way to address the problem would be to seek credit guarantees from the government to “absorb” this risk.

It is likely that both the centre and states will overshoot their fiscal targets this year. The consolidated cost of vaccination, for one thing, is likely to go up from Rs 35000 crores that the central government budgeted has states procure their own vaccines at significantly higher prices that were initially assumed. Besides, more fiscal support is needed both sectors like hospitality and aviation collapse and also for individuals like daily wage workers who have lost their livelihoods.

The RBI should use its liquidity levers to ensure that additional government borrowing absorbed by the market without a sharp spike in bond yields. If interest rates are allowed to rise, the central bank could compromise post second-wave economic recovery.

Monetary policy amidst of a major shock like the second Corona wave can afford to “look through” some inflationary impulses. While it is true that rising commodity price inflation is a problem and could travel soon from the wholesale to the retail index, there is every reason to believe that with subdued demand the second round or pass- through effects will be muted.

Besides, the past fifteen months have shown us that there are intermittent and unexpected episodes of inflation in some items. These seem to be driven by supply problems induced by the pandemic and do not warrant monetary attention. The most that the RBI can do at this stage is to goad the centre and states to manage the supply of essential items

Specific recommendations:

  • Moderate downward revision to growth for FY22 in light of the second wave impact to 9-10 per cent.
  • Continue with unchanged repo and reverse repo rates and accommodative.
  • Offer higher reverse repo rates for targeted lending to specific sectors.
  • Announce GSAP amount for 2Q FY22 of at least Rs 25000 crores. Indicate willingness to increase this amount should fresh borrowings arise (such as Rs1.58 trillion likely to bridge GST compensation cess shortfall).
  • Indicate that “ credit guarantees” from GOI critical for last mile delivery of credit to target sectors

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

The second wave is a big shock to the entire economy, impact of the second wave which though peaked in May, implies that the first quarter is almost lost. The severe uncertainty, domestic and global, that is prevailing in the current year is absolutely immeasurable. More so now, given that today, Maharashtra has reported the beginning of the 3rd wave with nearly 8000 children in a single district suffering from COVID19. The country is expecting, in 20 to 30 weeks, the setting in of the third wave. The main issue is, the 2nd wave has hit the hinterlands of the country and rural population has been impacted. The 3rd wave is expected again to impact both urban and rural areas. If the third wave is going to play sometimes around September to November then the uncertainty increases more because that is the busy season when a lot of growth activities are taking place in the country post-monsoon and much of manufacturing activity and construction activity takes place. So, the uncertainty in general and sector-wise is extremely large. The double-digit WPI need not be a long-term phenomenon and should not turn out to be a major threshold for discussions in policy at the RBI. If the long-term trend during the year of WPI and CPI is analysed, it can be agreed that trend is within the range. The monthly data of manufacturing, especially the IIP, reveals that the performance is better in March 2021 compared to March 2020, despite the uncertainty associated with the pandemic. The eight core industries performance has also been reasonably okay in recent months, but there may be some dents due to the 2nd and 3rd wave. –The main point is the industry is waiting for a let up and even if a small window of opening up, the lockdown either eases or opens up, the manufacturing sector, mining and electricity, are going to boom. The monsoon is predicted to be normal and therefore, agriculture sector should continue on its steady path, which is positive.

The banking trends are mixed as credit flow to the economy is slow. According to the RBI’s recent Annual Report, the provision coverage ratio is much higher at 88 percent for the period ending December 2020 compared with 81 percent in March 2020. The capital to risk weighted ratio has increased to 15.9 percent from 14.8 percent, which is very positive. The growth in investments in G-Sec’s have almost doubled from the year before rising to nearly 20 percent from nearly 10 percent a year ago. The return on assets is positive in December 2020 vis-à-vis, negative in the previous year closing. As it stands now, the banking sector is performing reasonably well under the supervision of the RBI. Looking ahead, with the 2nd wave in the first quarter, April-June, there is a fear because credit off take would not have taken place again. The slowdown in the economy basically due to the lockdown could impact the balance-sheet of the banks. So, the RBI will probably have to go in for provisioning and extending the accommodative stance, and continue with its liberal policies where it has accommodated the commercial banks in the previous year. If the 3rd wave hits and if so in the busy season, the RBI’s role will have to be far more aggressive in taking care of the banking sector. The RBI may also have to take additional care of the NBFC and MFIs which are also suffering a severe blow.

To conclude, the fiscal situation in the country will continue under stress in the current year, because of the lockdown and the accommodative fiscal policy that have to be announced to take care of various sectors. The time has come to borrow more aggressively from the market that can have interest rate implication or go for monetized deficit. In any case, it is a challenge in the current fiscal year but the Fiscal Responsibility Budget Management Act can be given a pause.

The RBI should continue its accommodative policy. The rates of interest which are there in the advanced countries today, the US Federal Reserve, Australia, UK and Euro continues to be near 0, and New Zealand is 0.25. The inflation in these countries is also low. On the aspect of growth, it would be very useful if RBI is able to convey a signal that though inflation is a concern, given the mandate of the Central Government, but growth/unemployment is probably a bigger concern and therefore, a reduction in the Repo rate by 25 basis points when the economy is on the verge of the 3rd wave, can be considered.

Guest Panellists

Special Guest

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

Mr Siddhartha Sanyal mentioned about how his earlier expectations of over 20% plus growth in Q1 FY22 has now come down to about 14%. As regards growth forecasts for the coming quarters too, he preferred to err on the side of caution. This is also reflected from the RBI’s consumer confidence survey. In the month of March 2020, RBI’s consumer confidence index stood at 86 which later came to 54 over the next about four months despite several fiscal and monetary policy announcements. The index has largely stagnated since then till the break out of the second wave. Now, with a severe second wave the improvement of consumer confidence will likely be materially delayed, thereby acting as a discernible headwind for growth recovery even though industry and policymakers are better prepared this time to deal with the pandemic. Overall, monetary policy needs to stay supportive despite CPI readings potentially breaching the RBI’s “upper tolerance band”. Finally, while the macroeconomic situation is fraught with challenges, the strong contra-cyclical stance and deft use of unconventional monetary policy by the RBI in the recent past remains encouraging. Continued policy support is the need of the hour for the bottom of the economic pyramid (eg., poor households, MSMEs), especially after the harsh second wave.

Guest from ASSOCHAM

1. Shri Rishi Gupta, Co-Chairman, ASSOCHAM National Council for Banking and MD & CEO, Fino Payment Bank Ltd.

On the economic front, Mr Rishi Gupta mentioned about RBI providing various COVID related reliefs. To ensure such reliefs, PPI & other guidelines are being relaxed by RBI. Though the pandemic has impacted the industry especially MSME on a large scale, India is still doing better on the global platform.

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

Talking about the overall economic scenario, he apprised the participants that the overall impact of COVID are not likely to be as huge. The GDP is around 1.6% for 4th Quarter. He further observed that the RBI is expected to continue its previous accommodative stance. Talking about the current scenario, he stressed that around 1 crore people have lost their jobs due to the pandemic. Given an economic overview, he discussed the Bank Credit rate, which has seen a growth of 5.7%. Further, retail inflation is currently at 5.1% compared to previous rate of 5.4%. This was due to growth in auto sales and electricity consumption, which has improved than the previous times. Talking about the relief packages, he mentioned that the Ministry is working on Stimulus Package for worst hit sector. It is expected that RBI will ensure ample credit to rural sector through special window. In this regard, relaxation to smaller NBFC should also be extended.

3. Shri Raman Aggarwal, Director, Finance Industry Development Council (FIDC)

Welcome move by RBI to bring NBFCs in the main stream through stricter regulation and supervision and recognize the importance of the sector in servicing the under-served and credit-deprived segments of society. However, there are many instances of NBFCs being deprived of required regulatory support in lending and customer service in comparison with banks:

  • NBFCs do not have any refinance / lender of the last resort mechanism
  • A dedicated “Refinance Window for NBFCs”, on the lines of NHB (for HFCs) has been a long-standing demand of the NBFC sector, with separate limit carved out for smaller NBFCs.
  • RBI has mandated all NBFCs to report the performance status of all their exposures of Rs.5 crore and above on the CRILC platform. However, NBFCs are denied access to CRILC information. It would be fair to permit the NBFCs access to the platform, for their own credit administration. We urge upon RBI to provide to the NBFCs full access to the CRILC platform, and to start with to all Systemically Important NBFCs.
  • Hon’ble Finance Minister had announced on 23rd August, 2019 that NBFCs shall be allowed to use bank KYC and no need for separate KYC to be done. Since, the entire money flow to both the investors and borrowers of NBFCs happen through the Aadhar seeded and KYC authenticated bank accounts, the need for fresh KYC is a mere duplication.
  • Recent instance of NBFCs not being treated at par with banks, Ins Cos, Mutual Funds and even stock brokers as essential services during lock downs.

The business of many NBFCs include education loans to students to finance their higher education expenses in India and abroad and Education Institution Loans

(EIL) for financing education infrastructure growth needs of schools, colleges and universities. It is pertinent to note that Education Sector has not been included in the identified 26 stressed sectors whereas there has been serious impact of COVID-19 on the education sector as well including closure of Schools/Colleges etc resulting in a negative social and economic impact. Further, due to the continuing adverse impact of COVID-19, MoF introduced ECLGS 3.0 to cover Business Enterprises/MSMEs in Hospitality, Travel & Tourism, and Leisure & Sporting sectors. And recently, ECLGS 4.0 has included healthcare and aviation sectors. Education Sector is excluded from scope of ELGS 3.0 and ECLGS 4.0 as well. Therefore, we sincerely request your support in inclusion of Education sector in ECLGS.

NBFCs business model requires deep regional presence in tier towns III-VI, personal touch with the customers for loan disbursals and instalment collections, local banking for remote cheque facility and banking for cash collection of instalments. Most banks have regional presence requiring NBFCs to tie up with multiple banks to service its customers in chosen states. RBI may advise banks that the restriction on current accounts is not applicable to NBFCs insofar as they are required for collection and remote cheque issuance for loan disbursals so as to facilitate flow of credit to the remote places and efficient management of funds.

Mid-Year change in auditors is disruptive for the NBFCs preparing quarterly results. Challenge of finding eligible audit firms with right skills given various restrictions such as cooling period, number of audits, partner strength of audit firm, audit / non audit services for the group to which an NBFC belongs to, within short span of time. There are operational issues on which RBI clarifications are requested. Taking into account the avowed objective of the independence of auditors – Our prayers are for keeping the guidelines in abeyance at least for the current FY.