Monetary policy must remain accommodative

With the Covid second wave refuelling uncertainty about the economic outlook, the Monetary Policy Committee (MPC) is expected to remain cautious, and extend the status quo on the key repo rate, as well as the accommodative stance in its second review for FY22. Also, it may modestly revise its CPI projections up, while cutting its growth forecast for FY22.

Since the last policy review, the CPI inflation has recorded a base-effect led dip to 4.3 per cent in April 2021. The GDP grew by a tepid 1.6 per cent in Q4 FY21, resulting in a full-year contraction of 7.3 per cent in FY21.

Despite the continued vaccination drive, Covid-19 cases have witnessed a second surge, including a higher incidence in the rural areas. The ensuing localised lockdowns across various States have weakened the momentum of various high frequency indicators over the course of the last two months.

The sharply higher daily infections in the second wave is likely to have a prolonged negative impact on consumer sentiment. In addition, the substantial healthcare expenses related to Covid treatment and high retail prices of fuels are likely to squeeze disposable incomes and discretionary spending. And with input prices having soared, margins in many sectors are likely to shrink.

Uncertainty ahead

As a result, the hopes of a double-digit expansion in the current year have been doused. With uncertainty rife regarding the near-term outlook, GDP (at constant 2011-12 prices) growth in FY22 is likely to be in a range of 8-9.5 per cent.

By how much the Indian economy eventually grows in the current year will crucially depend on whether an accelerated vaccine rollout can prevent a third Covid surge, and whether localised restrictions have to be re-imposed later this year.

Over the next few months, CPI inflation is likely to rise as the lockdown base fades away. Local supply disruptions for perishables such as vegetables, the trend in non-vegetarian protein items, as well as the global trend in the prices of edible oils, will play a critical role. However, a normal south-west monsoon, as projected by the IMD, should help cap the prices of cereals and pulses.

The global recovery and vaccine rollout optimism have pushed up global prices of commodities like crude oil, copper, steel, etc. Nevertheless, with domestic demand likely to be uncertain post the second wave, pricing power is likely to be subdued, limiting the transmission of high commodity prices to the core-CPI.

The CPI inflation could moderate to 5.2 per cent in FY22 from 6.2 per cent in FY21, while remaining well above the mid-point of the MPC’s medium term target range of 2-6 per cent. As a result, there doesn’t seem to be any space for rate cuts to assuage the uncertain growth outlook.

What about fiscal support? A higher-than-anticipated tax revenues helped to curtail the Central Government’s fiscal deficit for FY21 to ₹18.2 trillion, modestly below the Revised Estimate (RE) of ₹18.5 trillion.

Simultaneously, the food subsidy has overshot the FY21 RE by ₹1 trillion, which perhaps corresponds to the prepayment of Food Corporation of India’s liabilities to the National Small Savings Fund in FY21, that were earlier planned to be serviced in FY22.

This suggests a cushion of ₹1 trillion in FY22 within the budgeted level of expenditure, which will help to absorb the already announced costs related to free foodgrain and fertiliser subsidy (around ₹400 billion), as well as the expected enhancement in the MGNREGS allocation that may be needed following the Covid surge.

At this stage, there is a modest risk that the government’s fiscal deficit in FY22 will be higher than the budgeted ₹15.1 trillion, especially on account of shortfalls in disinvestment receipts. Accordingly, the space for a fiscal stimulus appears to be limited and would need to be carefully targeted.

Monetary as well as credit policy will, therefore, have to continue to play a critical role to support the economy through the continuing uncertainty. The monetary policy stance may remain accommodative for a large part of 2021, until the vaccine coverage improves dramatically.

After the recent GST Council meeting, a loan of ₹1.58 trillion was announced to address the expected gap between the GST compensation requirement of State governments and the cess collections in FY22. In line with the practice in FY21, this loan would be raised by the Centre and passed on back-to-back to the State governments.

With a confirmation of ₹1.58 trillion of additional sovereign borrowing in FY22, the size of the anticipated secondary market government securities acquisition programme (GSAP 2.0) will be keenly awaited, and will crucially guide the outlook for G-sec yields over Q2 FY22.

The writer is Chief Economist, ICRA