Background and Introduction
As the global economy continues to recover amidst the resurgence of COVID-19, the rapid spread of the Delta variant and the threats of new variants have increased uncertainties of overcoming the pandemic. This is also making policy choices difficult with multidimensional challenges of subdued employment growth, rising inflation, food insecurity and setback to human capital accumulation leaving very little room to manoeuvre. The global economy is expected to grow 5.9% in 2021 and 4.9% in 2022 (WEO October 2021). The slight downward revision in global growth (from the July WEO update) is largely due to downgrade for advanced economies- a part led by supply chain disruptions and worsening pandemic dynamics for low-income developing countries.
It is broadly realized at this juncture of the pandemic reoccurrence that the principal drivers of the gaps are vaccine access and policy support. India, as one of the largest producers of vaccines in the world is expected to contribute to the global progress towards a pandemic solution. After initial hiccups, vaccinations picked up reasonably. At the current pace, India is likely to vaccinate about 40% of its population by end-2021.
India during the first and second waves of the COVID-19 have reacted with different policy measures starting from full nation-wide lockdown to localized lockdown measures with phased reopening of economic activities however, despite dynamic policy support, the aftermath of the pandemic has led to a deep and broad-based economic downturn, followed by a gradual recovery. India prior to the COVID-19 shock was already slowing with growth at 4% in FY 2019-20, reflecting a decline in private domestic demand. At the start of the pandemic Indian policymakers and authorities have undertaken several emergency measures both on fiscal as well as the monetary front. Monetary easing, liquidity, and regulatory measures for the financial sector, as well as credit and debt relief programs for borrowers were announced along with structural reforms. The first wave led to a GDP contraction of 7.3% in FY 2020-21 with contact-sensitive services, construction, mining and manufacturing being most impacted. Supply chain disruptions saw investment and employment fall sharply with private consumption down 9% and gross fixed capital formation, 10.8%. Inflationary pressures persisted from food supply shocks and supply chain disruptions. Inflation peaked at 7.6% in October 2020 but although inflation eased recently, elevated core inflation at 5.8% reflects broad-based price measures.
It thus calls for strong policy intervention by the Central Bank of India-Reserve Bank of India (RBI) in tandem with the Government’s fiscal support. The RBI has provided significant, broad-based monetary easing through interest rate cuts and accommodative forward guidance. On the back of the pandemic risks, the monetary policies adopted by the RBI until recently and its impact on the Indian economy are discussed in this paper.
Reserve Bank of India and its Monetary Policy Stance
Accommodative monetary policy by the RBI has helped ease liquidity measures giving households access to money. Since the pandemic, repo and reverse repo rates were cut by 115 and 155 basis points (bps) to 4 and 3.35%, respectively, building on the pre-pandemic easing of 135 bps; the cash reserve requirement was reduced by 100 bps. The accommodative policy stance was aided by both time- and state-contingent forward guidance on policy rates and, more recently, on asset purchases, to better anchor market expectations amid unprecedented uncertainties.
Various liquidity measures resulted in a cumulative injection of over 6 percent of GDP during February 2020 – 2021 and helped avoid a broad-based liquidity crunch for both financial and nonfinancial corporates. The recent formalization and market guidance on asset purchases has helped anchor market expectations amid unprecedented uncertainties. The impact of the announcement of asset purchases on longer-term yields has been in line with that in other emerging markets. Continued asset purchases should allow market forces to be reflected in prices and to preserve central bank credibility.
As the second wave retarded momentum, the negative impact of it on growth requires continued monetary policy support while accounting for any fiscal support that ensures liquidity support reaches viable firms in vulnerable sectors. Together with this, inflationary pressures need to be monitored with implications for growth-inflation trade off.
In the most recent RBI monetary policy released in October 2021, the policy rates were left unchanged. Repo rate continued at 4% while reverse repo and MSF remained at 3.35% and 4.25% respectively. While global economic recovery momentum ebbs under the rapid spread of Delta variant in many countries, the Indian economy till now is recovering as reflected by recent data. The rebound in economic activity gained traction in August-September led by retreating of infections, easing of restrictions and a sharp pick-up in the pace of vaccination. Industrial production posted a high year-on-year growth for the fifth consecutive month in July. The manufacturing PMI at 53.7 in September remained in positive territory. Services activity gained ground with support from the pent-up demand for contact-intensive activities. The services PMI continued in the expansion zone in September at 55.2, although some sub-components moderated. High-frequency indicators for August-September – railway freight traffic; cement production; electricity demand; port cargo; e-way bills; GST and toll collections – suggest progress in the normalisation of economic activity relative to pre-pandemic levels. Headline CPI inflation at 5.3 per cent in August softened for the second consecutive month driven by easing food inflation. Core inflation, however, remained elevated and sticky.
Going forward, the inflation trajectory is set to edge down in the next quarter of the year, drawing comfort from the recent catch-up in kharif sowing and likely record production. In addition to adequate buffer stock of food grains, these factors should help in keeping cereal prices range bound. Vegetable prices, which are a major source of inflation volatility, have remained contained so far this year and are expected to remain soft, assuming no disruption from unseasonal rains. Supply side interventions by the Government in the case of pulses and edible oils are helping bridge the demand supply gap; the situation is anticipated to improve with kharif harvest arrivals. The resurgence of edible oils prices in the recent period, however, is a cause for worry. On the other side, pressures persist from crude oil prices which remain volatile over uncertainties on the global supply and demand conditions. The CPI headline momentum is moderating with the ease in food prices which, combined with favourable base effects, could bring about a substantial softening in inflation in the near-term.
As domestic activity is gaining momentum, going forward rural demand is expected to maintain its buoyancy due to the above normal kharif sowing and bright rabi prospects. The significant acceleration in the pace of vaccination, the sustained lowering of new infections and the coming festival season is anticipated to support a rebound in the pent-up demand for contact intensive services, strengthening the demand for non-contact intensive services, while reinforcing urban demand. Monetary and financial conditions will continue to be easy and supportive of growth. Capacity utilisation is improving, complementing the revival in business outlook and consumer confidence. The broad-based reforms by the government focusing on infrastructure development, asset monetisation, taxation, telecom sector and banking sector is likely to boost investor confidence, enhance capacity expansion and facilitate crowding in of private investment. The outlook for aggregate demand is progressively improving but the slack is large: output is still below pre-COVID level, and the recovery is uneven and critically dependent upon policy support.
The RBI monetary policy tone is encouraging to instil confidence for business improvement and growth while anchoring inflation within the target rate and remaining watchful of the risks- both domestic and international.
Monetary Policy Stance-Advanced Economies
According to the RBI, the total monetary support extended globally by central banks is estimated to be about US$18.0trillion as of August 2021. This support has been predominantly in the form of asset purchases, around US$11.6 trillion, followed by lending operations of US$4.4 trillion. The policy stance has remained divergent across countries with a few major AEs and EMEs maintaining an accommodative stance while the others beginning or continuing withdrawal of monetary stimulus.
Fed in its latest FOMC meeting held in September kept interest rates unchanged but remained committed to the tapering of bond purchases if the progress is as expected. Despite risks of the new Delta variant and slow jobs growth data, the Fed is hopeful that progress in vaccinations and strong policy support will improve economic activity and employment. The Fed noted Inflation being elevated, largely reflecting transitory factors. Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.
The ECB in review of the financial conditions and economic outlook kept the key ECB rates unaltered with moderately lower pace of net asset purchases under the pandemic emergency purchase programme (PEPP). The Euro-Area is witnessing an increasingly advanced rebound phase in the pandemic recovery. Output is expected to exceed pre-pandemic levels as more than 70% of the adults are fully vaccinated, the economy has reopened largely, consumer spending is rising, and production is also increasing. Inflation has edged up in the last reading mainly led by strong increase in oil prices, however, over medium-term inflation is expected to be well within the 2% target. The risks from the global spread of the Delta variant of COVID-19, however, could deter full reopening of the economy. Overall, the risks are broadly balanced as financial conditions of firms, households and the public sector look favourable (Bank lending rates for firms and households being at historically low levels, solid bank balance sheets, etc.). The economic rebound and recovery are thus much dependent on the course of the virus and progress of vaccinations. ECB’s forward guidance is focused on sustained recovery with inflation targeting.
Thus, the multi-speed economic recovery across countries is becoming increasingly susceptible to renewed bouts of rapid spread of infections. Globally, economies have seen a perceptible slowdown of economic activity in the recent months, particularly in Asia. Inflation remains high across the world, with supply disruptions becoming more widespread. The pervading threat of the delta variant has led monetary authorities – that had earlier signalled unwinding – to be on hold, while incremental inflationary pressures have made others signal a sooner unwinding.
As the country recovers from the ‘technical recession’ caused by the pandemic, few of the other risks that may have downside effects on the Indian economy include:
- Regional tensions between the South Asian neighbours-China, India and Pakistan. Tensions along the borders will continue to remain top priorities of the countries.
- Intensifying of farmer protests led by the Parliament passing key farm bills have warned supply chain disruptions and logistics deterring economic recovery from the pandemic.
In the aftermath of COVID-19, risks from geopolitical shifts are likely to remain the major challenge for India. Border tensions and implications of it will also have adverse effects on the revival of the economy.
The Indian economy is picking up steam amidst the stressful global risks’ situation. Recovery although is uneven and trudging through soft patches, the step-up in vaccinations, fall in new cases/mortality rates and normalising mobility has rebuilt confidence. Domestic demand strengthening while recouping aggregate supply conditions as manufacturing and services revives is indicating economic improvement going forward. Inflation expectations are also in close alignment with the target.
The RBI in its policy meeting also announced additional measures on developmental and regulatory policies as further liquidity measures and easing financial conditions and inclusion. These included:
- To tap the potential of MSMEs and help them overcome the aftereffects of the pandemic a three-year special long-term repo operations facility (SLTRO) which was introduced in May 2021 has been extended till December 2021.
- To promote ways for digital economy, initiatives were undertaken to introduce
offline mode of retail digital payments especially in remote areas.
- Deepening digital payments penetration across countries was identified to be a priority area for financial inclusion. To accelerate the pace of setting up a Payments Infrastructure Development Fund (PIDF), Geo-tagging of Payment System Touch Points is to be established. This step is envisaged to ensure a balanced spread of infrastructural acceptance across length and breadth of the country.
- Further impetus was provided on priority sector lending by bank registered NBFCs. This, in turn, is expected to have a trickledown effect on growth of employment and economy.
- The Committee observed that NBFCs have played an increasingly important role in encouraging financial inclusion. Thus, to further strengthen the NBFCs, emphasis was given on developing the Internal grievance redress mechanism of NBFCs.
Thus, the outlook remains overcast by the future path of the pandemic. Nonetheless, the accelerated progress in the pace of vaccination, release of pent-up demand in the upcoming festival season, boost to investment activity from the government’s focus on infrastructure and asset monetisation, and accommodative monetary and liquidity conditions provide an upside to the baseline growth path. A faster resolution of supply chain disruptions, good food grains production and effective supply management is likely to cause inflation to undershoot the baseline, contingent on the evolution of the pandemic and the efficacy of vaccines.
 World Economic Outlook, IMF, October 2021
 International Monetary Fund-Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for India, October 2021.
 RBI Monetary Policy Statement, October 2021
 RBI Monetary Policy Report, October 2021
Author: Antara Mukherjee