India’s Q1FY22 GDP came in at 20.1 percent and GVA at 18.8 percent. Stellar numbers no doubt on a YoY basis but at Rs 3238 trillion, Q1FY22 GDP fell short of GDP in Q4FY21 as also in Q1FY20. Importantly, the private consumption expenditure quantum in Q1FY22 too fell short of Q4FY21 numbers, implying a continued pushback in this area.
Gradually, India’s macros are getting better as it comes out of the stress associated with the 2nd COVID-19 wave. But everything is not well yet, especially as it is still not certain if there is a durable damage to consumption and to what extent. Consequently, private sector investments have been lagging and will continue to do so. On the other hand, the organised production sector is back on its feet with profits largely staying in the black even with the localised lockdowns of the 2nd COVID wave. Business confidence surveys conducted by the RBI tend to indicate that the mood is relatively buoyant. However, this story does not incorporate the informal sector, that probably continues to show a reasonable amount of stress.
On the other hand, inflation data surprised with a lower-than-expected print. Headline CPI was at 5.3 percent in August, but the core CPI inflation remained relatively sticky. Our own calculations show that inflation prints are likely to glide lower over the next few months. Further, our model indicates that the inflation data over the remaining part of the year could turn out to be lower than RBI’s own current estimates. For instance, RBI’s Q3FY22 estimate is at 5.3 percent while our own calculations point to a range of 4.6-4.8 percent. We do see headline CPI rising in Q4FY22 on the back of an adverse base of last year and average at 5.7-5.9 percent, but still within the tolerance band.
More crucial is to understand the implication of the above data on the monetary policy meeting of October. To understand this better, we take reference to the speech titled ‘Monetary Policy: Trial by Pandemic’ by Dr Patra, DG, RBI on September 16, 2021 at the Financial Markets Summit of the CII. A few very important and interesting points have been made in this speech.
First, he reiterates the confidence of RBI that the current high inflation is “transitory” and that it has an element of supply shock in it. He points out that inflation is emanating from a small group of items. 20 percent of CPI items is currently driving 50 percent of inflation. Further, the distribution of inflation has skewed to the right side and this, according to him, indicates persistence of supply shocks. The understanding currently with RBI is that the supply augmenting measures of the government will help cool off inflation. However, the downward journey of inflation could be very slow and gradual due to 1) pass-through of imported price pressures to retail prices is still not over and 2) wage growth in the organized sector has risen even as rural wage growth and house rentals stay muted.
Even as the markets are confident that repo rate will not change, they fear that RBI will normalize monetary policy via draining out liquidity and by increasing the reverse repo rate. This speech makes it clear that actions on liquidity is no indication of tightening and that any tightening will be preceded by a change in stance. He pointed out that the credit channel of transmission was broken, and the RBI used the repo-reverse repo rate corridor as a policy instrument to ease financial conditions and to keep the “lifeblood of finance flowing”. Importantly, RBI hopes that credit demand will recover and in a natural way will reduce the LAF surplus.
On the growth front, Dr Patra points out that the output gap is still negative and is wider than it was in FY20, a year that was unaffected by Covid-19. This probably means that the RBI is likely to continue to tilt towards nurturing the growth objective within the dual mandate of ‘price stability, keeping in mind the objective of growth’.
In view of the above, I expect RBI to largely maintain status quo and not pursue any tightening measures till the end of FY22, unless there is clear evidence that growth is back on its trend path. Another important perspective spelt out in the speech emerges in the following quote: “Independence in monetary policy relates to the freedom to choose a rate of growth and inflation that is independent of global growth and inflation but is right in the national interest”. This clearly indicates that RBI will probably steer clear of following developed market central banks in their effort at tightening financial conditions.
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