RBI 'cautiously optimistic' about economic recovery after Covid second wave

Second Covid wave shaved off Rs 2 trn from FY22 output, says central bank in 'State of the Economy' report in its June bulletin

The Reserve Bank of India (RBI) sees reasons to be “cautiously optimistic” as the second wave of the pandemic seems to have hit domestic demand, while other economic indicators show the economy is coming back on stream.

While the Indian economy continued to wrestle with the second wave of the pandemic, “cautious optimism is returning”, the RBI said in its “State of the Economy” report in its June bulletin.

“By (the) current assessment, the second wave’s toll is mainly in terms of the hit to domestic demand. On the brighter side, several aspects of aggregate supply conditions -- agriculture and contactless services are holding up, while industrial production and exports have surged amidst pandemic protocols,” the RBI said in its report, the lead author of which is Michael Patra, deputy governor of the central bank. Citing statistical and mathematical models, the RBI said “greater improvement was expected by early July”.

Stressing that the speed and scale of vaccination would shape recovery, the article said that the economy had the “resilience and the fundamentals to bounce back from the pandemic and unshackle itself from pre-existing cyclical and structural hindrances”.

The central bank in its June policy lowered its gross domestic product (GDP) estimate to 9.5 per cent for 2021-22, from 10.5 per cent earlier.

The forecast was done on the assumption that the impact of the second wave would remain confined to the first quarter of the year, and will be helped by the base effect of last year’s “precipitous contraction”.

Quantifying the impact in the first quarter, the RBI said the second Covid wave could shave off Rs 2 trillion from 2021-22 output. However, the second wave has reached smaller cities and villages, impacting rural dem­and. This time the government may not be in a position to spend as much as last year to revive demand, the RBI said. 

The central bank also defended the transfer of Rs 99,122 crore as dividend to the government. The nearly Rs 1 trillion transfer, according to the RBI, was “just 0.44 per cent of GDP”, and was generated through “saving on balance sheet provisions and employees’ superannuation and other funds”, the RBI said.

The RBI, the report said, is “free-ranging and conducting independent monetary policy, i.e., independent of fiscal dominance”, it said. 

The central bank pointed out that notwithstanding the second wave, goods and services tax (GST) collection in 2021-22 so far had fared better than in 2020-21, “infusing optimism that the revenue base for states will be protected with a growth rate of 7 per cent, and it may result in some surplus to compensate for the shortfall in the previous year”.

GST collected in May was Rs 1,02,709 crore, which was 65 per cent higher than that in the same month last year. 

However, pressure points remain. For example, vehicle sales have plummeted, and air travel has shrunk. But railway freight held up. Labour market weekly indicators, which started waning since the first week of April, started recovering in the second week of June, the RBI said. But pressure on inflation will continue due to rising volatility in international commodities. Volatility in the last decade has weakened the relationship between the consumer price index and wholesale price index.

Still, globally, central banks see the surge in inflation as transitory and “talk down speculation about dialing back their easy policy stance”, while “frictions flare with every incoming data”. The Monetary Policy Committee (MPC) has forecast a 5 per cent inflation rate for 2021-22 with risks broadly balanced.

“We have to learn to live with the virus, complementing vaccines with ramping up investment in healthcare, logistics and research,” the RBI said.

There is a need to ensure that recovery is “built on a solid foundation of business investment and productivity growth”, it said.

In a separate article, the RBI said slope of the yield curve have steepened with abundant liquidity bringing down short-term interest rates more than proportionately alongside a pick-up in issua­nces of ultra-long dated paper. There was a scope for moderation of longer-term yields from current levels, it said.