RBI faces fresh challenge with Covid-19 second wave

“We must accept finite disappointment, but never lose infinite hope,” Reserve Bank of India (RBI) governor Shaktikanta Das quotes the famous words of Martin Luther King Jr from his 1968 address in Washington D.C. as concerns over the second wave of Covid-19 infections sweep the country.

Das knows the recent spurt in cases has suddenly added uncertainty to the domestic growth outlook amidst tightening of restrictions by some state governments. “We are now better prepared to meet the challenges posed by this resurgence in infections. Fiscal and monetary authorities stand ready to act in a coordinated manner to limit its spillovers to the economy at large and contain its fallout on the ongoing recovery,” he said after unveiling the first bi-monthly monetary policy of the new financial year, on April 7.

On the very day, India reported a new peak of 1.26 lakh fresh cases of infections, with nearly half of it coming from Maharashtra. Two districts of Mumbai and Pune have each reported over 10,000 fresh cases daily, forcing the state government to introduce a partial lockdown. The fresh lockdown, expected to last for a month, entails a complete shutdown at night and on weekends, and limited activity during weekdays.

A couple of months after the vaccination programme and its steady progress strengthened the prospects of a quick turnaround in economic growth, the recent surge in infections has left a pall of gloom. The central bank believes that the localised and regional lockdowns could dampen the recent improvement in demand conditions and delay the return of normalcy. It delivered a verdict that the monetary policy should remain accommodative to support and nurture the recovery. The monetary policy will remain accommodative till India attains a sustained recovery, says the central bank.

Credit rating agency CARE Ratings said in a report that Maharashtra's lockdown will have an economic impact of ₹40,000 crore, with the trade, hotels, and transport sectors to bear the biggest dent. The rating agency said the loss of economic activity will have a 0.32% impact on the gross value added (GVA) growth at the national level. CARE has already revised down its national GDP growth estimate to 10.7%-10.9% from the 11%-11.2% it predicted nearly two weeks ago.

According to the RBI, the pandemic presents both upside and downside risks to the baseline growth path. A faster decline in infections helped by a rapid vaccination drive, large pent-up demand for contact-intensive services, and stronger global demand provide an upside to the baseline growth path. On the flip side, the uncertainty associated with the spread of the pandemic, including the new mutants of the virus, raises a major risk for the growth.

The RBI is also counting concerns over a potential spike in inflation. After moderating close to the target rate in January 2021, the headline inflation had firmed up to 5% in February 2021. The central bank believes that the evolving consumer price index (CPI) inflation trajectory is likely to be subjected to both upside and downside pressures. On one side, the bumper food grain production during the last financial year should result in softening of cereal prices going forward. Mitigation of price pressures on key food items such as protein-based components and edible oils would also depend on supply-side measures and easing of international prices. On the other side, high international commodity prices and logistics costs may fuel inflation pressures.

Soon after the policy was unveiled, which left the key rates unchanged, the rupee plunged 1.5% to 74.55 (against the U.S. dollar), its biggest one-day drop in the last 20 months, during the trade on April 7, and closed at 74.43. The central bank had announced that it would buy ₹1 lakh crore of bonds in the secondary market during the first quarter under the new G-Sec Acquisition Programme 1.0 (G-SAP).

The G-SAP programme, which will start on April 15 with a ₹25,000-crore bond purchase, will enable an orderly evolution of the yield curve. The central bank doesn’t want a sudden spurt in bond yields and is trying everything possible to keep it under its wings.

The rupee had remained under depreciating pressure till mid-November 2020 due to “Covid-related uncertainty, risk aversion, and capital outflows”. Subsequently, the currency appreciated, riding on the domestic recovery gaining traction, decline in the number of new infections, vaccine rollout, and the measures announced in the Budget 2021-22 to revive the economy. However, the rupee depreciated sharply towards the February-end, riding the volatility in the global financial market on account of the spike in sovereign bond yields in the U.S. and other major economies. The RBI had pegged the exchange rate at ₹72.6 per U.S. dollar for 2021-22, taking into account these developments.

With the vaccine rollout and easing of lockdown restrictions, the global economic activity has shown a relative improvement, although it remains uneven across countries and sectors. The International Monetary Fund (IMF) in its January 2021 World Economic Outlook (WEO) update projected the global economy to expand by 5.5% in 2021, though it depends heavily on the progress with the measures meant to contain the pandemic and the scale and speed of the vaccination programme. The World Trade Organization (WTO) has meanwhile suggested a moderation in global merchandise and services trade volumes from the marked improvement reported in October-December 2020 quarter.

In India, the outlook for inflation after breaching the upper tolerance threshold of 6% for six consecutive months (June-November 2020), CPI inflation fell in December 2020 and eased further in January 2021 to 4.1% on the back of a sharp correction in vegetable prices and softening of cereal prices. It rebounded to 5% in February, however, driven primarily by base effects. Core inflation pressures remained elevated, with inflation excluding food and fuel at 6% in February, reflecting pass-through to retail prices from higher crude oil and non-oil commodity prices, high fuel, and other taxes post-Covid-19, along with increased operating costs.

The March 2021 round of the RBI survey said the inflation expectations of urban households have seen a rise, in March 2021, in tandem with higher food and oil prices. Manufacturing firms polled in the January-March 2021 round of the RBI’s industrial outlook survey expected further input cost pressures. Similar results were also found in the Purchasing Managers Index (PMI) survey for the manufacturing sector, which reported a strong increase in input prices in March 2021 along with higher output prices. For the services sector, input cost inflation was at an eight-year high while selling prices remained stable in February, reflecting efforts to boost sales.

Professional forecasters surveyed by the apex bank in March 2021 expected CPI inflation to ease from 4.9%-5% in the first half of 2021-22 to 4.3% in the third quarter and revert to 5% in the fourth quarter.

The central bank said the private final consumption expenditure (PFCE), the mainstay of aggregate demand, which was severely dented during the pandemic, revived in the second half of FY21. Spending on transport, hotels and restaurants, recreation and culture, which together contribute around 20% to PFCE, have also reported an improvement in the fourth quarter. Several high frequency indicators of private consumption crossed pre-Covid-19 levels, holding up a broad-based momentum. Passenger vehicle sales remained healthy and posted double-digit growth in January and February 2021, partly reflecting shifting of preferences towards own vehicles over public transportation in the wake of the pandemic. The production of consumer durables, which collapsed in the first few months of the pandemic, bounced back to go beyond pre-Covid-19 levels in December 2020. The domestic air passenger traffic is still tepid and around two-third of pre-Covid-19 levels, reflecting lacklustre activity related to tourism and entertainment, and with business meetings increasingly preferring the virtual mode.

During FY21, the fiscal position of the central government remained under stress due to revenue shortfalls and increase in Covid-19-related discretionary spending. Revenue collections have however gathered pace in the second half. The centre’s net tax revenue increased by 9.1% during April-February 2020-21 and stood at 90.4% of the revised estimates (RE) for the full year.

Despite Covid-19-related spending, states’ revenue expenditure (excluding interest payments and subsidies) rose marginally during April-January due to expenditure rationalisation, says the central bank.