In its latest policy statement, the RBI projected India’s GDP growth for the 22nd fiscal year at 9.5%, taking into account a balance of risks and rewards. However, with the possibility of a third wave of Covid looming, do you think economic growth will meet the expectations of the central bank?
To start with, we are forecasting growth of 9.2%. This forecast takes into account the impact on growth of the second wave of the pandemic. As for a third wave, it is very difficult to predict its onset, let alone its timing or intensity. Therefore, it’s just too difficult for the RBI or anyone else to fit it into a forecast.
But let’s just take the second wave as a guide. While the wave itself was severe, the recovery was quite satisfactory and it was fairly quick. We have seen a fairly rapid improvement in various mobility indicators such as electricity production, electronic bills, etc. In general, it therefore seems that, on the one hand, companies are adapting to this type of shock and, on the other hand, the effects have so far been quite short. lived.
At the same time, a major risk is that the economy’s immunity to the multiple shocks of the pandemic will erode over time for several reasons. First, household net financial savings have normalized. Recall that during the first wave, these economies had jumped to more than 20% of GDP and that the pent-up demand that was released during the reopening was enormous. It’s less likely now.
The second is that with a public debt close to 90% of GDP, the budgetary margin to face a new wave is now even more compromised. And then there is not much that further monetary accommodation can accomplish. Interest rates are already strongly negative, liquidity improvements and sector-specific lending programs are already in place and yet bank lending has been timid.
So overall there are too many unknowns, making it difficult to quantify the impact of a possible third wave.
On the growth-inflation front, the RBI faces a delicate situation. While inflation may moderate below the highs seen in May and June, supply side issues persist. Realistically, the central bank will have to revise its forecasts for the coming months. What do you think the RBI should do at the next policy meeting?
Our assessment of inflation in India is that it is becoming persistent, that is, it may remain above its steady state for an extended period.
Several developments are contributing to this. Aside from the usual suspects like high commodity prices and supply side disruptions, the operating environment has changed in the sense that there is a greater concentration of the large business market. It is conceivable that India’s potential growth has declined and therefore the price pressures are emerging earlier than before.
In fact, the May CPI reading of 6.30% y / y was quite telling. Regardless of how you shell it, whether you looked at the core, whether you looked at the core-core or the super-core, there was tremendous price pressure. So this reading of inflation was very serious. The situation did not change significantly in June.
So what is the RBI likely to do? He is obviously in a rather difficult situation.
First, the current estimate of 5.1% for a full year will be revised upwards. The RBI will attribute part of the increase to supply disruptions, the high tax structure on petroleum products and potentially focus on the need for tax measures. And it is also conceivable that some members, in their minutes, raise the risk that inflation expectations will become more entrenched.
But when it comes to concrete action, the current state of the business cycle allows only small steps. It is too early to offer anything on the conventional side, ie the key rate.
Where we’re likely to see something (and this may or may not be communicated in the policy) is that the amount of the excess will start to moderate. There are a few instruments for this.
We already have variable rate repurchase agreements; their terms can certainly be extended. I think there is a strong case for setting up a special deposit facility to absorb excess liquidity. And then, tactical intervention in the futures market is possible. Please keep in mind that none of these instruments need to be explicitly defined in monetary policy.
Another potential conundrum for the RBI is liquidity in the banking system. Due to large-scale Treasury bill repayments this quarter and continued central bank bond purchases through various types of OMOs, the surplus is expected to increase further. Given the inflation indicators, would it be desirable for the RBI to slow down some of its operations?
The RBI should definitely stick with the GSAP programmer, as there is always a need to support government borrowing. But it can ease some of the other liquidity enhancement measures and use the instruments I just mentioned.
After this quarter, the amount of excess liquidity is expected to moderate. The BoP surplus, while strong, is likely to be smaller than last year. We don’t need so many TLTROs etc. than last year. There is therefore a good chance that the situation will not remain super generous.
The RBI has provided significant support to the bond market to keep sovereign borrowing costs low during the pandemic. But given the scale of the bond supply, do you think the RBI risks creating a distorted pricing situation out of touch with fundamentals?
The good news is that we have gone from the 6% mark to something above it. This suggests that there is now a little more propensity to allow the benchmark yield to adjust. At the same time, it is too little compared to the deterioration of public finances.
Thus, with regard to public finances, the deficit of 6.8% this year is achievable mainly because the collection of tax revenues has been prudent. But the medium-term fiscal outlook is very difficult for several reasons.
First, the kind of fiscal dynamism we’re seeing this year typically only happens in the first year of a recovery. After that, we fall into a more normalized range as nominal GDP growth and corporate profits stabilize. Complicating matters further is that India’s potential growth has also declined.
Overall, our estimates that bringing government debt below 85% of GDP will be very difficult. Unfortunately, this level is quite high and this risk premium must be reflected in asset prices.
From a market perspective, we have seen that the Indian rupee had benefited from significant inflows last year. Given the difficult growth outlook, how do you think foreign investors would view the Indian currency and the sovereign debt market? Once the CAD starts to widen again, do you expect the rupee to depreciate?
I think there are a few issues here and overall the chances of the rupee depreciating are quite low. Let’s start with the current account deficit. Due to the resumption of growth and in terms of the trade shock linked to the rise in commodity prices, the current account will become in deficit but moderate by just over 1% of GDP. Moreover, it seems that the phase of the fastest surge in oil prices is now behind us. Take crude oil prices which are now struggling to exceed $ 75 / barrel.
We remain optimistic on capital flows – the growth of the recovery combined with strong spending containment should continue to attract capital inflows. We also continue to see flows in Indian unicorns that continue to surface.
A solid BoP surplus is therefore still in sight. And finally, the perception of the rupee has clearly changed over the past year. Now that foreign exchange reserves are over $ 600 billion, it is very difficult to make the rupee a speculative target or even worry about the rupee.
We’ve seen this kind of development in the past with a few other economies like Taiwan, which is how well a currency behaves with an oversized reserve kitty.
You mentioned that credit growth has been quite anemic; banks still face balance sheet problems. Should the RBI extend more regulatory waivers at this point?
They must certainly continue with that for this year. Beyond this, we must not lose sight of the fact that India’s NPA problem did not arise out of the pandemic but rather was a pre-existing condition.
There has to be an effort to figure out which loans are legacy issues and which will be addressed alongside an economic recovery. And then each type of problematic loans should be dealt with appropriately. Unfortunately, these questions have become quite confusing over the past year and a half.
Have the government’s measures to propel economic growth during the pandemic been sufficient? What more can the government do to return to the path of sustainable growth, given that GDP was slowing well before the pandemic?
To be fair, the government and the central bank did what they could within their constraints. There was very little budget space at the start.
Having said that, let me take a controversial position here. Our thinking about taxation has become somewhat stereotypical – capital spending is good and revenue spending is bad. And for fiscal 22, the focus was on capital spending. But the nature of the current crisis is different: it is a humanitarian crisis which calls for more massive social measures. Much of our population has fallen into poverty, income and wealth disparities are widening.
So while I recognize that asset creation has a greater multiplier on growth, this crisis is also unique and requires a different response.