Monetary policy review: RBI expects 'modest' recovery in Jan-March

Six months into FY21, the Reserve Bank of India (RBI) released its first estimate of economic growth in 2020-21 as its October monetary policy committee (MPC) meeting ended on Friday.

Accounting for the impact of the pandemic, real gross domestic product (GDP) in FY21 will fall 9.5 per cent, the MPC noted in its statement.

In that, the RBI gave quarterly estimates. After a 24 per cent fall in Q1, the central bank expects real GDP to fall 9.8 per cent in Q2, shed 5.6 per cent in Q3, and grow 0.5 per cent in Q4, with January-March marking the first quarter of a “modest” recovery.

As growth recovers, the MPC said inflation would moderate towards the range 4.5-5.4 per cent in the remainder of FY21.

It will further ease to 4.3 per cent in the first half of 2021-22, it noted, but with caution about “substantial” risks to the outlook if supply-side responses were not strong enough. The committee said growth was its priority this time, and the inflation surge was transient in nature.

“The MPC is of the view that revival in the economy from an unprecedented Covid-19 pandemic assumes the highest priority in the conduct of monetary policy. While inflation has been above the tolerance band for several months, the MPC judges that the underlying factors are essentially supply shocks which should dissipate over the ensuing months as the economy unlocks, supply chains are restored, and activity normalises,” the MPC statement said.

While the rural economy is coming back on track, the MPC said urban demand revival looked difficult due to rising Covid-19 infections and social-distancing measures. It expects the “contact-intensive” services sector to recover at a later stage, compared with manufacturing, which would “gain traction” in Q4.

“Both private investment and exports are likely to be subdued, especially as external demand is still anaemic,” it said in its report.

Moderation in inflation will be on account of the progressive easing of lockdowns and the removal of restrictions on inter-state movements. Similarly, food supplies will also increase after the kharif harvest.

But the demand indicators look problematic in the MPC’s assessment because the pricing power of firms remains weak.

Supply disruptions have elevated food prices, more for protein-rich food items such as eggs, meat, and pulses than cereals. Experts said the RBI assessment on growth was a shade more positive than what the current indicators suggested.

“The projection of mild growth in Q4 appears to be coloured by the spate of positive data for September 2020, the sustainability of which is as yet uncertain. We remain circumspect about generalising these early green shoots, as they have benefited from base effects and one-off shifts in some sectors,” said Aditi Nayar, principal economist at ICRA.

In its half-yearly Monetary Policy Report (MPR), published with the policy, the RBI gave two scenarios: One, a rapid improvement in the Covid situation and supply easing, and, two, deterioration in the pandemic and delayed vaccine. In a faster than expected improvement in containing the pandemic, the GDP fall could be restricted to 7.5 per cent, but it could worsen to 11.5 per cent in the adverse scenario.

But there is a catch here: In the favourable setting, oil prices are expected to rise — with existing production cuts in place — which will push inflation upwards from the expected numbers.

The MPR expects consumer demand to pick up sooner than investment demand, led by rural demand. Investment, “hamstrung by low capacity utilisation”, may take longer to stabilise, it noted. It also predicts 10 per cent real GDP growth in FY22.