Experts disagree with MPC stance that inflation will fall below 4% in H2

RBI acknowledges economy will contract in the current fiscal even as independent experts have already assessed so.

The Reserve Bank of India (RBI)  has, in a first, acknowledged that the economy will contract in the current financial year — something that independent experts have already assessed. It is in this context that the central bank’s Monetary Policy Committee (MPC) cut the repo rate by 40 basis points (bps) despite a “highly uncertain” outlook on retail inflation. The MPC expected the high inflation rate to be short-lived, expecting it to fall below 4 per cent in the second half of the current financial year. Experts have countered this view. No one in the government was earlier of the view that the economy will shrink this financial year. However,  government officials have now agreed with the RBI’s views on both GDP contraction and inflation. “We broadly accept RBI’s view on contraction in the economy,” a senior government official told Business Standard.

Earlier this month, Chief Economic Advisor Krishnamurthy Subramanian had said that GDP growth for the year could be around 2 per cent. After this, Expenditure Secretary TV Somanathan had said while he broadly agreed with the CEA’s assessments, he believed that GDP growth could be lower than that, but certainly not higher.

 “These are evolving situations. The CEA’s assessment was some weeks ago. The available data has changed since then. Also, he gave one of the many internal assessments that we have. Based on certain scenarios, there is also an assessment for contraction for the year and that we should be prepared for a significant growth shock,” said the official, after the RBI governor’s address.

On the governor’s assessment of inflation, the official said: “Non-food inflation is weak because of low commodity prices. There is spike in food inflation because of supply-side disruption related to the lockdown. But even that will unwind by the second half. In that case, inflation may drop below the 4 per cent target.” RBI Governor Shaktikanta Das expects gradual revival in the economy during the second half, after the possible lifting of the lockdown and the stimulus. However, this has a downward bias as the governor said much depends on how quickly the Covid-19 curve flattens.

The RBI’s assessment came even as independent experts estimated the economy to contract from 5-7 per cent in FY21. Even on Friday, ICRA further cut its projections for the economic contraction. From the earlier expectation of a 1-2 per cent fall in GDP for FY21, it now expects the decline to be 5 per cent.  “We now expect GDP to report contractions of 25 per cent and 2.1 per cent for Q1 and Q2 of FY21, which implies a recession,” said Aditi Nayar, principal economist, ICRA.  On the assumption that the lockdown will be completely lifted within the first quarter of FY21, Nayar expected a V-shaped recovery.

“However, if there is a second wave of infections that forces subsequent lockdowns either in India or globally, the ensuing demand uncertainty and supply chain hiccups could result in a W-shaped economic cycle, the inflection points of which can’t be gauged now,” she added.

Only agriculture provides some hope. Das used figures released by the agriculture ministry to say that amid this encircling gloom, agriculture and allied activities have provided a beacon of hope. The third advance estimates pegged foodgrain production at a record 295.67 million tonnes for FY20.  In addition, there was forecast of a normal monsoon in 2020 by the India Meteorological Department (IMD). 

By May 10, kharif sowing was higher by 44 per cent over last year’s acreage. Rabi procurement was in full flow with respect to oilseeds, pulses, and wheat, benefiting from the bumper harvest, said the RBI.  “These developments will support farm income, improve terms of trade facing the farm sector, and strengthen food security. Going forward, these will have a salutary effect on food price pressure,” said Das.  Madan Sabnavis, chief economist at CARE Ratings, did not agree with the MPC’s assessment.

He said: “Inflation will remain above 4 per cent — closer to 5 per cent — in the remaining months of FY21,” he said.  According to Sabnavis, while demand in the non-food segment is low, supply has also been disrupted, and hence inflation will be high. On the food side, inflation has not reduced despite good Rabi production, as there is a tendency to recoup earlier losses. This is likely to happen at the time of Kharif crops as well, he said.

 The RBI also feared that the high food inflation may persist for a few more months, depending on the extent of the lockdown and restoration of supply chains.  The consumer price index (CPI) for food and beverages rose to 151.4 in April, from 148.9 in the previous months. However, caution should be exercised in  interpreting this number, given many sub-groups such as meat and fish are missing in the April data on account of the lockdown.

The central bank is particularly worried about inflation in pulses, and has urged the government to “reappraise” import duties, besides taking other supply-side measures. CPI in pulses stood at 150.4 in April, against 141.1. The RBI also wanted the Food Corporation of India to offload some of the excess cereal stock to cool prices down and create room for rabi procurement.