Extreme economic uncertainty but worst could be over, says outgoing MPC

Even when it improves, the expectation is one of slow, hesitant recovery, with the situation likely to worsen before it gets better

The final policy review by the incumbent monetary policy committee (MPC) showed rare unanimity among members, who voted for a pause and adopting a ‘wait and watch’ strategy. 

This was on the back of a gradual pick-up in economic activity even as inflation remained above the upper limit of the mandated 6 per cent in the last six months.

Food prices — the major reason for the spike in inflation over the last six months — was seen softening, though the members felt there were chances of prices flaring up again, showed minutes of the meetings released on Thursday. 

After cutting the policy repo rate by 135 bps since the lockdown began in March and an overall 250 bps in this cycle since February 2019, the MPC decided to keep the repo rate unchanged at 4 per cent and stance at “accommodative”. “Outlook for the domestic economy remains extremely uncertain, as the impact of Covid-19 has been more severe than initial assessments suggested. Also, the global economy rem­ains vulnerable to a renewed surge in community infections and fears of a second wave,” noted Reserve Bank of India (RBI) Governor Shaktikanta Das in the meetings held between August 4 and August 6.

“Even as high-frequency indicators suggest some momentum in July, the near-term outlook remains uninspiring with large downside risks,” said Das, pointing to a disconnect between the relatively buoyant global financial markets and underlying economic fundamentals.

Nevertheless, moderate recovery in the domestic economy is in play, though the nascent signs of recovery in June have again slumped after the renewed spate of infections forced re-imposition of lockdowns, according to the governor.

“The agriculture sector remains a beacon of hope,” he added, hoping for the rural economy to show robustness while industrial and services activity recover gradually. Overall economic recovery will be conditioned by supply disruption, and compression of consumption demand (especially non-essential goods and services), will depend on the containment of the virus and unlocking of economic activity, said the governor.

However, the members struck a positive note, suggesting that the economy may have weathered the worst. 

“In terms of output loss, my assessment is that the worst is almost surely behind us (notwithstanding the second wave),” said external member Chetan Ghate, even as the exact damage caused by the pandemic is difficult to gauge.

Noting that the Consumer Confidence Survey by the RBI in July showed the Current Situation Index at a historic low, external member Pami Dua said: “Clearly, it is important to revive the economy and mitigate the impact of the pandemic, in line with the objective of the monetary policy — to maintain price stability while keeping in mind the objective of growth.”

Though there are “high uncertainties” and “contradictory evidences about the characterisation of the current and future macroeconomic environment”, external member Ravindra Dholakia remained sceptical “about the deep stagflationary conditions”.

“Although the present circumstances are truly exceptional, the primary mandate given to the MPC for inflation targeting at 4 per cent, with the upper tolerance limit of 6 per cent, has to be respected,” said Dholakia, adding that the policy rate transmission was commendable but not complete and hence the central bank must ‘wait and watch’.

All three external members end their four-year term in September, and a new set of external members will take charge in October. Among internal members, executive director Mridul K Saggar was the new member, succeeding Janak Raj.

“Growth estimates for FY21 are difficult to arrive at, in the current juncture, but there could be downward bias to the present consensus estimates, when the final data becomes available. Inflation, on the other hand, may have an upward bias,” said Saggar.

Deputy governor Michael Patra was disappointed with the inflation surprises, blaming them on “supply disruptions and unrelenting cost push interventions in price formation”.  This is outside the ambit of monetary policy and has complicated its conduct, especially as inflation levitation seems to show persistence.