MPC: Covid surge, lockdowns add uncertainty to growth outlook, says Das

External member Jayanth Varma saw little merit in persisting with RBI’s forward guidance as it failed to flatten the yield curve, and the pandemic made forecasting difficult

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Reserve Bank of India | MPC minutes | Coronavirus


Anup Roy  | 
Mumbai 

The second wave of coronavirus infections, and its impact on growth, loomed large on the minds of the six monetary policy committee (MPC) members, according to minutes of the meetings released by the Reserve Bank of India (RBI).

The members were also in favour of engaging with the bond market. One external MPC member Jayanth R Varma ruled that RBI’s forward guidance has failed to bring down yields and that practice can be stopped. The RBI announced bond buying worth Rs 1 trillion from the secondary market in the first quarter.

In the end, the MPC decided to keep the policy repo rate unchanged and the stance at accommodative “for as long as necessary to sustain growth on a durable basis and continue to mitigate the impact of Covid-19 on the economy, while ensuring that inflation remains within the target going forward.”

Edited minutes released showed that even as the RBI kept its growth forecast for the financial year unchanged at 10.5 per cent. However, most members were not very sure how the second Covid wave would play out.

“Rapidly rising cases of Covid-19 is the single biggest challenge to ongoing recovery in the Indian economy,” RBI governor Shaktikanta Das said.

The economy was evolving on the lines of the February MPC resolution with improving demand conditions, investment enhancing measures by the government and improving external demand imparting an upside to growth prospects, but the recent jump in Covid-19 infections and its impact on economic activity needed to be watched carefully.

The “need of the hour” was to “effectively secure the economic recovery underway so that it becomes broad-based and durable,” governor Das said, adding, “the RBI would take all steps, as needed, to ensure orderly conditions in the financial markets and to preserve financial stability.”

Deputy governor Michael Patra said the recent rise in inflation could be looked through while the focus could remain “on reviving the economy on a path of strong and sustainable growth.”

“An integral part of this approach would be to insulate domestic financial markets from global spillovers and volatility so that congenial financial conditions continue to support growth,” Patra said.

RBI’s executive director Mridul K. Saggar said the economic recovery could come under risk if the new wave of infections was not flattened soon, especially as “monetary and fiscal policies have already used most of their space to considerably limit loss of economic capital.” Expansion of policy toolkits, though, could still afford additional comfort, according to Saggar, who heads the monetary policy department.

The rise in infection could retard full normalisation by a quarter or two, and so ramping up vaccination, testing and treatment held the key to protecting economic recovery. Health policies have become the first line of defence, while the “monetary and fiscal policies can only play a second fiddle.”

The baseline projection in growth of 10.5 per cent was on account of an “all-time low base,” he said, adding, the “realisation of the projected growth will translate to only a meagre average growth rate of 0.85 per cent in two years following 2019-20.”

This provided justification for the monetary policy’s continued support to growth, Saggar said, adding both consumption and investment needed to be stimulated. Capacity utilisation rate at 66.6 per cent was well below the long-term average of 73.6 per cent.

An upturn in capex cycle will require “larger public investments that can crowd in private investments,” and that consumption needed support from removing credit frictions and more redistributive policies, according to Saggar.

“The pace of recovery of output needed to offset the negative impact of the Covid 19 shock to the economy in terms of growth in income and employment will be substantial and sustained over many years,” said external member Shashanka Bhide.

According to Bhide, the easy monetary policy has supported in sustaining economic activities and recovery of growth, and that such policy environment would be needed to strengthen and broaden the ongoing recovery process.

The second wave in many countries have been “sharp but short,” noted Ashima Goyal. The effect on growth could be marginal if complete lockdowns and bans on interstate movement are avoided, but the “nature of the virus and its ability to mutate imply too much unlocking can create a surge.”

The base-effect facilitated growth rate of above 10 per cent “does not imply sustained growth at potential,” she said. The growth rate would “barely take us to the level we had reached in 2019. We have to also make up for lost time; alleviate widespread job loss and income stress.” A sustained recovery can only be called a true recovery, according to Goyal.

She pointed out that the spread of the 10-year bonds over short rates remained about 60 basis points over 2011-17, but “the current spread of over 200 basis points, despite large OMO support, points to markets being caught in an irrational trap.”

“Indian markets also need firm and clear guidance. Once market fears recede interventions required would reduce,” she prescribed.

Jayanth R. Varma was more forthcoming, and said RBI’s forward guidance has “failed to flatten the yield curve,” and he saw “little merit in persisting with it any more.”

The principal motivation for the forward guidance was to reduce long term yields in the backdrop of an excessively steep yield curve. A flattening of the yield curve remained an important goal but, “it must be pursued using other instruments which largely lie outside the remit of the MPC.”

In the aftermath of the pandemic, forecasting has become more difficult and “economic and statistical relationships have tended to break down in the current exceptional environment.”

It was not prudent to “repose excessive faith in forecasts. Instead, the MPC must have the agility and flexibility to respond rapidly and adequately to whatever surprises new data may bring in future. Time based guidance is inconsistent with this imperative,” Varma said.

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