RBI Monetary Policy June 2022- The juggling task should not keep the growth objective out of the radar

 

 The narrative around inflation have been strengthening regularly since March 2022 and the calls for interest rate hikes have escalated quickly. The consumer price inflation surged to an 8-year high of 7.8 percent in April 2022, the fourth consecutive month above the upper-band of the RBI’s flexible inflation target (4% +/- 2%).

The Monetary Policy Committee (MPC) of the RBI raised the policy repo rate by 40 bps to 4.40 percent in an off-cycle meeting on May 4, 2022. The stance of the MPC remained accommodative but in the previous two policies (April and May), inflation concerns have outweighed weakness in economic growth. The broad market consensus of the February 2022 policy was that the MPC was relatively dovish with inflation projected to ease from 6 percent in January 2022 to 4.2 percent by the last quarter of FY23. Revival of economic growth also took centre-stage.

In a span of three months, tables have reversed and market expects the policy to be relatively hawkish with the policy repo rate to be hiked by atleast 100 bps by the end of this fiscal in order to reign in the headline retail number and anchor inflation expectations. Many analysts also expect the RBI to hike the repo rate by 50 bps and further tighten the banking system liquidity by 50 bps increase to the cash reserve ratio (CRR). The CRR was raised by 50 bps in the off-cycle meeting to flush out the excess liquidity surplus aggregating Rs 87,000 crs.

The arguments made so far for rate hikes have been more attuned to retail inflation remaining above the 6 percent target for a sustained duration, need for anchoring inflation expectations and lingering global inflationary pressures sapping consumer sentiments. Contrastingly, there have been some arguments which conclude that a contractionary monetary policy response to tackle price escalation due to an oil supply shock may not be the appropriate response.

Ahead of the MPC meeting scheduled for tomorrow, are we undermining the sustained weakness in the domestic growth impulses while giving persistent inflation too much importance? Could an aggressive policy response by the MPC dampen the nascent growth recovery? Are the present aggregate demand conditions robust enough to enter a faster rate-hike cycle?

Firstly, the Indian economy during Q4-FY22 grew by 4.1 percent, the third straight quarter of decline in GDP growth primarily led by a sharp deceleration in private consumption expenditure and decline in the growth of gross fixed capital formation (GFCF). On the supply side, the manufacturing sector reported disappointing numbers (contraction of 0.2 percent) while the construction section grew modestly by 2%.

Industrial output (IIP) also grew by a subdued pace of 1.9 percent in March 2022. The capacity utilisation has inched above 70 for the first time after 9 consecutive quarters but is still lower than the decadal pre-pandemic average of 73. 

In a recent report by Nielson IQ, the sales volume of consumer goods fell by 4.1 percent for Q4-FY22 (y-o-y) with a great contraction of 5.3 percent witnessed in the rural markets. This can be partly ascribed to rising input cost pass-through by FMCG companies or by reducing the package size and keeping price unchanged, popularly called as “shrinkflation”.

These macroeconomic indicators reflect a gloomy as well as uncertain environment with some signs of improvement. An aggressive bet on policy rates could derail this recovery.

Secondly, the high frequency indicators as released in the State of the Economy report by the RBI shows a mixed picture. The year-on-year growth in passenger vehicle sales till April 2022 continues to witness a contraction while the growth over the pre-pandemic month (April 2019) for two-wheeler sales and three-wheeler sales continues to be negative (30 percent contraction for 2-wheeler sales and 50 percent contraction for 3-wheeler sales in April). Domestic air cargo and passenger traffic has seen sequential improvement but comparison with pre-pandemic month (April 2019) is still negative. This is the case with international air passenger traffic as well. The y-o-y growth in steel consumption was modest at 1 percent in April 2022 while the growth for cement production is moderating. The silver lining has been E-way bill collections and the PMI values for both manufacturing and services.

Lastly, bank lending has seen a renewed optimism with non-bank food credit growing by 11.3 percent in April 2022 (y-o-y) and this has been broad-based with credit to industry registering a growth of 8.1 percent, services by 11.1 percent and personal loans by 14.7 percent. An RBI Working Paper (2018) concludes that economic activity and non-food credit positively impacts investment activity while real interest rates and gross fiscal deficit negatively impact. In one of the previous instances of rate hike in from 6.25 percent in Dec’2010 to 8.5 percent in Oct’2011, non-bank food credit decelerated from 27.7 percent to 18.9 percent. There has been a similar adverse impact on credit growth observed during 2013-14 (another period of rate hike) as well. With gross fiscal deficit elevated, real interest rates rising and economic activity in a recovery stage, aggressive rate hikes could adversely impact the non-bank credit channel, which could indirectly have a bearing on the investment activity and economic growth.

Till the February 2022 MPC meeting, the revival and durability of economic growth was of paramount importance with inflation taking back seat. The macroeconomic environment has definitely changed in a short span and raising policy rates is inevitable in the June 2022 meeting. However, the weightage assigned to economic growth in the popularly Taylor rule (econometric model that describes the relationship between nominal interest rates, inflation, economic growth) should not change much. Aggressive monetary and fiscal policy action to supply-side led inflation pressures could significantly derail India’s economic growth recovery.

COVID-19 and the economy | The mirage of growth numbers

 

The impact of COVID-19 first wave on individuals and the industrial segment was immense and the impact of the second wave could be equally damaging for both, not being reflected by macro-economic growth numbers

 There was an emerging euphoria about the rebound in the economy during the last quarter of FY21. It was widely acknowledged that owing to a low base in Q4-FY20 and H1-FY21, growth numbers would be attractive, leap-frogging to the FY20 number by the far-end of FY22 and re-commencing the growth trajectory from FY23 onwards.

The ferocious COVID-19 second wave has halted the recovery trajectory and given everyone a reality check.

After initial expectations of double-digit growth for the economy by various institutions, the resurgence of the pandemic has dented the recovery process and downward revisions to single-digit growth projections have been pervasively resurfacing. However, analyst expect the second wave to have a muted impact on the economy with vaccination drives and better healthcare preparedness.

Despite supply chains remaining less impacted during the second wave, the widespread nature of the contagion impacting both urban and rural regions and percolating to the skyscrapers in the urban areas, the impact on the aggregate demand could be much severe than the previous lockdown and is likely to be hidden in the ‘mirage’ of macro-economic growth numbers.

Azim Premji University’s recent release of the State of India Working 2021 report, which provides a comprehensive and micro-level assessment, is an eye opener and the 15 percent contraction estimated in H1-FY21 is just the tip of the iceberg. Monthly per-capita income fell by 17 percent during the pandemic, primarily affecting daily-wage workers, self-employed and temporary salaried.

During April and May 2020, the poorest 20 percent households lost 100 percent of their income, while households in the top echelons of the income bracket suffered losses less than 1/5th of their pre-pandemic income.  About 230 million i.e 16 percent of India’s population fell below the national minimum wage threshold (Rs 375 per day). Estimates suggest that poverty rates to have increased by 15 percent (rural) and 20 percent (urban) on account of the pandemic disruptions. About 20 percent of the households reported that food essential had not recovered even six months after lockdown.

The impact on unemployment was the most severe on women with 47 percent suffering a permanent job loss. If this has been the severity following the first wave, the impact on aggregate demand following the second wave, which has four times the case-load, could be ravaging.

One can argue here that the economy is better prepared based on the lessons from the first wave, speedier inoculations and the pent-up demand narrative will drive the economy again from H2-FY22. However, the question is: are we looking only at the top 5 percent of the individuals to take the economy forward? ‘Forced savings’ during the first lockdown translated into spending on discretionary items during the second half of FY21, but this time around, with cash flows diverted towards essentials and healthcare during the second wave by a larger section, the resurrection of discretionary spending is likely to be more prolonged.

Similar to consumption and income of individuals, the impact on the industrial segment of the economy has also been immense and the second consecutive year of de-growth in industrial productions reflects de-industrialisation in the economy. Even prior to the outbreak, industrial output grew at a subdued pace of 3.1 percent during FY16 to FY20. Although this can be conjectured to weak demand for industrial products, the bank credit off-take to industries has averaged 2.2 percent during FY16 to FY20 with medium-scale enterprises registering a fall of 3 percent and micro enterprises recording close to nil growth.

To alleviate the impact of nation-wide lockdowns on industries, the central government did extend emergency guarantee-based credit line to MSMEs and there has been a 28.8 percent growth registered in credit to medium scale enterprises — but outstanding credit to micro enterprises grew only by 0.5 percent.

Additionally, industrial credit by the NBFCs has registered double-digit contraction during each quarter commencing March 2020 till December 2020. Large-scale industries look confident, albeit lower than the start of 2021, about pick-up in recovery in FY22, but both waves of the pandemic would have strongly disrupted the MSME business operations.

In case of services businesses, the scenario is more akin to June 2020 with some segments such as IT, telecom, financial relatively better, transportation, education being stable, while contact-intensive segments such as hospitality, travel adversely being impacted. With the second wave gradually reaching the rural districts, albeit still lower than the peak seen in the first wave, the impact could be more damaging on the non-agriculture activities of the rural economy, accounting for two-third of the rural economy.

COVID-19 has had far-reaching implications on individuals and business and despite the intervention by the governments and central bank, there has been a long-lasting impact. Various macro-economic numbers will reveal a rosier side about the economy, but the ground-reality following the second wave is likely to be quite contrary to it and quite similar to the first wave. Pace and universality of vaccine administration and relief measures to the vulnerable sections of the society will act like a ‘cooling balm’ on the scar and may lessen the far-reaching and unequal implications of the second wave to some extent.

Sushant Hede is Associate Economist, CARE Ratings Limited. Views are personal.

The article was first published in the Opinion Column of Moneycontrol.com on May 25, 2021 (https://www.moneycontrol.com/news/opinion/covid-19-and-the-economy-the-mirage-of-growth-numbers-6934791.html)

Post #10 of the Quarantine series - India's government debt amidst the pandemic

The unprecedented coronavirus crisis has severely pressured the government finances. Not only is there expectations from the government to spend more for relief measures amidst these challenging times but also limited economic activities is weighing on the revenues of the government. There is one popular number which is often discussed which is “fiscal deficit” and that as a % of GDP. This number measures the quantum of borrowing to finance the gap between governments’ revenues and expenditure. Over time, just like an individual, the government repays the amount borrowed and borrows afresh. The residual amount which the government is likely to repay as on any given date is called as "outstanding government debt". 

There has been a lot of discussion about widening of India’s government debt since the announcement of the economic package and the 15^th Finance Commission (which looks after setting targets of fiscal deficit and government debt) is set to meet on May 21 to decide on the fiscal consolidation roadmap for 2021-22 to 2025-26. This roadmap will tell the target of fiscal deficit and government debt which they have to keep in mind over the next few years. Thus, post #10 of the Quarantine Series delves on some basics of government debt and tracks India’s debt positions over the years. 

Q1. What is government debt and what are the different variations/terminologies associated with it?

A1. Government debt is the outstanding amount of loan to be repaid by the government as on a given point in time. Different terminologies associated with it are provided in the chart below:

• Internal debt is the part of the government debt in a country which is owed to the lenders within the country. This is in the form of GSec (government securities), treasury bills, cash management bills, ways and means advances.
• External debt is the part of the government debt in a country which owed to the lenders outside the country. This form of borrowing is done from other governments and multi-lateral financial institutions like World Bank, IMF, other private institutions. 
• Total internal debt plus external debt is equal to public debt.
• Apart from public debt, there are other liabilities of the government like borrowings from National Small Savings Fund, state provident funds and other reserve funds.

 An equation below summarizes the above mentioned details: 

 Q2. How much is India’s government debt?

A2. India’s total government debt stood at Rs 146.9 lakh crs in as of 2019-20. This is the total debt of Centre and all the state governments taken together. Out of the total debt, 70% is held by the Centre while the balance 30% is held by the states. Popularly, the country’s debt is measured as a % of GDP. In India’s case, the India’s total government debt stood at 69.6% of India’s GDP in 2019-20. Total debt of the Central government is 48.6% while the 24.9% is that of the state governments in 2019-20. The trends in India’s government debt (As a % of GDP) has been provided below:

Chart 1: Trends in Indian governments’ debt to GDP ratio over the year

Q3. Where does India’s government debt to GDP stand in comparison to other countries?

A3. Out of a list of 173 countries, India ranks 38 in the ratio of government debt to GDP ratio which is notably lower than a few advanced economies like Japan, Italy, United States, France and United Kingdom. However, India’s debt is higher than Asian few peers like China, Thailand Malaysia and Philippines.

Chart 2: Country-wise comparison of government debt to GDP (%)

Q4. Why are we discussing about India’s government debt? Has there been any change in the number recently?

A4. Two developments on account of the coronavirus pandemic could have a bearing on India’s government debt.

• One is the likely increase in the central government’s fiscal deficit which means that the central government is likely to borrow more. India’s central bank has responded to this by increasing the government’s market borrowings to Rs 12 lakh crs for FY21, which is Rs 4.2 lakh crs higher than what was originally budgeted.
• Second is the likely increase in the state government’s borrowing during FY21 and this can be understood by the recent announcement by the Finance Minister to allow states to borrow additionally 2% of the GDP (out of which 0.5% is unconditional), subject to adherence to certain conditions. Even if the states avail the facility of additional borrowings, this could lead to states borrowing around Rs 2 lakh crs more from the market. 

So to put this in very simple terms, it means that as the governments are likely to spend more, they will have to fund the deficit by borrowing more and this could further add to the government debt. A back of the envelope calculation shows that India’s government debt to GDP ratio (both centre and states) could increase to 76-77% of GDP, from the current level of close to 70%. It was during 2002-05 when this ratio was little over 80%.

Q5. How has this number declined by almost 10% over the last 2 decades ? Is there some regulation implemented to monitor this?

A5. The governments have taken conscious efforts over the years to reduce the fiscal deficits over the years as the same has been mandated in the Fiscal Responsibility and Budget Management Act, 2003. Initially, the Act mandated the fiscal deficit to be reduced to 3% of GDP and only the recent FRBM Committee Review in May 2016 stated that this ratio should be targeted at 2.5% by 2023. In addition, the committee in 2016 also suggested using debt as a primary target and it was set at 60% of GDP (40% for the Centre and 20% for the states). In short, the committee has recommended that the government achieves a target of 60% by 2023. Given the uncertain times we are facing, a revision in the initial targets look likely.

Q6. Why is this increasing government debt number worrisome for the country?             

A6. The rising government debt has implications in the future in the form of additional interest cost for the government, puts pressure on interest rates which in turn can crowd out resources from the private sector and no additional fiscal space to deal with future shocks. In addition, two economists Reinhart and Rogoff have shown that for emerging economies there is a sustained increase in inflation in the country as the debt to GDP ratio increases.

 To end, I will like to pose a question to the readers: Will increasing government debt lead to higher inflation in coming years for a country like India or will we face deflationary trends like the one seen in advanced economies like Japan? Let's understand this point with some inputs from Irving Fisher's idea of the debt-deflationary trap in Post #11 of the Quarantine series. So do check out this space for the idea discussed above.  

Post #9 of Quarantine Series - An economic package for the Agriculture sector

Tranche 3.0 of the Finance Minister’s economic package gave me a feeling that I am watching Day 3 of a Test Match because the last announcement for the batsmen (i.e the farmer) on Day 2 was the starting point and focus area of Day 3 of the announcements. There were new batsmen of the team (animal husbandry, fisheries, bee-keepers, herbal cultivators) batting today and they held fort till the end of the day. However, today’s announcements were more of a long term solutions to address the concerns of the agriculture sector rather than an immediate action to help the agriculture community suffering from the pandemic.

Today’s announcement means that the aggregate amount has now reached Rs 17.67 lakh crs out of the stated Rs 20 lakh crs, meaning that a balance of Rs 2.33 lakh crs will be announced in the next few days (probably all analyst need to have patience like Rahul Dravid and hold fort for 2 more days).

A quick snapshot of today's announcement:

Announcements  on May 15	Amt (Rs crs)	Details	For what?
1)       Agriculture Infrastructure Fund	1,00,000	·     The government plans to create an infrastructure fund	·       For funding agriculture infrastructure projects like cold chains ·       Due to lack of adequate cold-chain and post -harvest management facility
2)       Micro food enterprises	10,000	·   To formalize the micro food enterprises, farmer producer organisations	·       The unorganized units  will be upgraded to improve their standards, integration with retail markets
3)       Fisheries	20,000	·   Under an existing scheme, Pradhan Mantri Matsya Sampada Yojana, the government will spend Rs 20,000 crs over the next few years	·       The spending will be done to improve and develop the marine and inland fisheries (including infrastructure)
4)       National Animal Disease Control Programme	13,343	·       Vaccination of the livestock	·       This will control foot and mouth diseases and brucellosis
5)       Animal Dairy infrastructure fund	15,000	·       An already existing fund which will get funding via NABARD	·       This additional funding is done boost the animal husbandry sector ·       Also drive private investment in dairy processing and cattle feed infrastructure
6)       Herbal cultivation	4,000	·       The spending will be done by the government over the next 2 years for cultivation of medicinal plants	·       Will get around 10 lakh hectares under herbal cultivation ·       Generate Rs 5000 crs of income
7)       Beekeeping	500	·   To spend to support the livelihood of beekeepers ·   The spending will be on infrastructure and implementation of standards	·       This will improve quality of crops and yields ·       Increase income of beekeepers
8)       Operation Green	500	·   To widen the ambit of an existing scheme named “Operation Green” by including all the fruits and vegetables	·       This will provide subsidy to the farmers to transport the fruits and vegetables from areas of surplus production to consumption centres
Total	1,63,343

Some key concepts:

Under 1) Agriculture Infrastructure Fund

a.    Who will fund this amount of Rs 1 lakh crs ?

Ans. The amount of funding will not be done by the Government of India, but will be done by National Bank for Agriculture and Rural Development. The clarity will be required on whether this funding will be via market borrowings or equity infusion into the NABARD. Most likely it looks like the former.

Under 2) Micro food enterprises:

a.     What are micro food enterprises/ farmer producer organisations?

Ans.  Micro food enterprises are manufacturers of packaged food products and having investments of less than Rs 25 lakhs for manufacturing entities and Rs 10 lakhs for services. Small and marginalized farmers come together and form an organisation called as farmer producer organisation.

b.    What is a cluster based approach?

Ans. A cluster is formed when several small firms come together and forms a hub. This is the exact example which the Finance Minister gave in her conference where she mentioned that commodities in which a state specializes will be identified and grouped together and formed into a cluster.  

Under 3) : Fisheries

a.     What is the Pradhan Mantri Matsya Sampada Yojana?

Ans. A scheme which was launched on July 5, 2019 aims to increase the fish and aquatic products through appropriate policy, marketing and infrastructure support. The idea is to build a robust fishery management framework.

Under 5) Animal Husbandry Infrastructure Development fund?

a.     What is this fund about?

Ans. This fund was created in March 2018 for the purpose of financing infrastructure requirement of animal husbandry sector with an initial corpus of Rs 2,450 crs. Today’s announcement will add Rs 15,000 crs into the already existing fund the money will be raised by NABARD.

Under 8) Operation Green

a.     What is the Operation Green scheme?

Ans. This is a scheme which was announced in Budget 2019 which will aid farmers to control the erratic fluctuations in the prices of tomatoes , onions and potatoes (TOP). In today’s announcement, the government has widened the definition from the TOP vegetables to all fruits and vegetables. Furthermore, the scheme states that it will provide 50% subsidy on transportation of the produce from surplus to deficient markets and 50% subsidy on storage.

What is the fiscal impact on the government?

The critical point to note in today’s announcement is not the actual cash outflow which the Government will undertake in one single year but how it will spread this across multiple years. For example, it has stated that the for herbal cultivation, the money will be spread across 2 years. Another example is the National Animal Disease Control Programe, where expenditure will be incurred across next 5 years.

Another important point to note is the outlay on different funds will not be done by the Government, but by the NABARD. Now, we have to wait for the details of how NABARD will raise the money (via equity or market borrowings)

Therefore, the impact on the finances of the government is not possible to calculate in FY21.

What are the 3 governance and administrative reforms announced by the Government ?

a.       Amendments to the Essential Commodities Act by which agriculture food stuffs including cereals, edible oils, oilseeds, pulses, onions are to be deregulated which means that any stock limit on these commodities will be imposed only under exceptional circumstances. In normal scenarios, there will be no stocking limit imposed on the producers producing these commodities.

b.      Agriculture Marketing Reforms where the Central Government plans to formulate a lawto provide:

a.       Adequate choices to farmer to sell the produce at the right price

b.      Barrier free Inter-state trade

c.       And build an e-trading framework

This will allow farmers to have more options in selling one’s agriculture produce not restrict oneself to only a few people in the APMCs.

c.       A legal framework to be created or farmers to engage with processors, aggregators, large retailers for producing those commodities which will provide assured returns.