The breakout of hostilities in Ukraine and its fallout may necessitate a review of the Reserve Bank of India’s GDP and inflation projections for FY23 even as the country’s growth story remains as weak as it was at the time of the 2013 ‘taper tantrum’, according to Deputy Governor MD Patra.

“While the fallout of the geopolitical situation is being assessed and will be factored into our projections, it is reasonable to treat it as a supply shock at this stage in the setting of monetary policy,” Patra said.

Taper tantrum refers to the spike in global bond yields in 2013 when the US Fed decided to taper its asset purchases, thereby ending the quantitative easing programme.

The Deputy Governor underscored that the recent reverberations of war have, in fact, tilted the balance of risks downwards when it comes to growth. RBI had projected FY23 GDP growth at 7.8 per cent in its February 2022 monetary policy review.

Patra observed that the government’s thrust on capital expenditure in 2022-23 can, however, be the gamechanger this time around by enhancing productive capacity, crowding in private investment and strengthening aggregate demand amidst the conducive financial conditions engendered by the RBI, and improving business and consumer confidence.

“Another silver lining is export performance...but unlike domestic investment, exports are in some sense hostage to global developments,” he said.

While RBI had projected inflation to ease to around 4 per cent by the third quarter of 2022-23, Patra noted that clearly, recent geopolitical developments pose an upside risk to these projections and the upcoming meeting of the Monetary Policy Committee (MPC) in April will provide a thorough reassessment.

But the focus of the monetary policy on price stability with clear accountability and the government’s proactive responses to keep prices in check provides confidence that India will weather this storm.

Easier to go into accommodation

“Although monetary policy has a predominantly domestic orientation, the effects of the imminent shift in gears will not be confined domestically.

“It will spill over to emerging market economies, and it will spill back to systemically important ones. It is always easier to go into accommodation than to come out,” Patra said.

The Deputy Governor said: “There are some spillovers which we have not seen before. Commodity prices have been surging in a synchronized manner. Energy prices, in particular, are shattering what were widely regarded as glass ceilings.

“...With new rounds of sanctions, US$ 125-150 levels (international crude prices per barrel) could be tested...Household spending could be sapped and the risk of a recession could intensify.

Contagion: 3 transmission channels

The Deputy Governor said for India, direct trade and finance exposures in the context of the ongoing conflict are limited.

Contagion could, however, impact India through a broader fall out on Emerging Market Economies (EMEs) as an asset class.

“The main transmission channel is likely to be global liquidity conditions, which are tightening. If worry were to give way to panic, liquidity, especially US dollar funding, could dry up and markets could malfunction.

“With crude oil still above $100 per barrel, new macroeconomic headwinds could be a second channel of contagion,” Patra said.

The Deputy Governor opined that a third channel could be the reassessment of geopolitical risk by markets and investors, which could inflate country risk premiums, raise the cost of funding for EMEs and reduce investment volumes. These factors may trigger re-calibration of forecasts, he added.

The Deputy Governor said with the tax component of pump prices still being substantial in the wake of increases during the pandemic, there is headroom available for reducing these taxes and cushioning the transmission of international crude prices to retail inflation.

Patra noted that stress testing baseline forecasts for normal times with extreme initial assumptions to approximate recent developments suggests that India’s recovery from the pandemic may continue to gain strength and traction on the innate strength of macroeconomic fundamentals, but is yet to be broad-based.

“...Consequently, the policy stance has to be carefully calibrated. Monetary policy remains in accommodative mode and continues to engender financial conditions that are supportive of growth.” he said.

Even though fiscal consolidation is underway, there is still some stimulus in the economy that will last through 2022-23, as estimates of the fiscal impulse suggest.