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ExplainSpeaking: Takeaways from the RBI’s latest Monetary Policy Report

This week, the discussion could be dominated by the choice of this year's Nobel prize winner for economics.

Written by Udit Misra , Edited by Explained Desk | New Delhi | Updated: October 19, 2020 12:27:10 pm
rbi, reserve bank of india, rbi's mpc, Monetary Policy Committee, monetary policy report, indian express

Dear Readers,

The biggest news of the past week was the monetary policy review. The October review was delayed because the Central government had not been able to nominate its quota of three members to the Monetary Policy Committee of the Reserve Bank of India.

Regardless of the delay, the eventual decision by the MPC — a status quo on repo rate — was hardly surprising.

Given that retail inflation — the variable RBI’s MPC is mandated to target by law — has stayed above the comfort zone for the most part since December last year, it was expected that the MPC will decide to wait before cutting repo rate (the rate at which India’s central bank lends money to the banking system) further.

Going into the meeting, however, the two more substantive issues were RBI’s assessment of how bad will the hit be to the GDP growth rate this financial year, as well as what is the outlook on inflation.

On inflation, the RBI expects a steady decline.

Explained | Why the RBI thinks a ‘faster and stronger rebound’ is feasible

“CPI inflation is projected at 6.8 per cent for Q2:2020-21, at 5.4-4.5 per cent for H2:2020-21 and 4.3 per cent for Q1:2021-22,” stated the policy statement.

In other words, with inflation expected to fall within RBI’s comfort band — that is, 4%, +/- 2 percentage points — in the second half of the year, there could be a repo rate cut in the coming months.

On GDP growth, the RBI laid down the marker and stated that it expected the economy to contract by 9.5% in the current financial year.

“The MPC is of the view that revival of the economy from an unprecedented COVID-19 pandemic assumes the highest priority in the conduct of monetary policy. While inflation has been above the tolerance band for several months, the MPC judges that the underlying factors are essentially supply shocks which should dissipate over the ensuing months as the economy unlocks, supply chains are restored, and activity normalises.

Accordingly, they can be looked through at this juncture while setting the stance of monetary policy. Taking into account all these factors, the MPC decides to maintain status quo on the policy rate in this meeting and await the easing of inflationary pressures to use the space available for supporting growth further,” according to the policy statement.

Read | RBI opposes loan moratorium extension: Will hit credit discipline

The RBI did try to compensate for the pause on rate cuts by further making it cheaper for new loans to be provided. It did this by tweaking the risk weights and bringing down the cost of creating credit for banks. It also provided more liquidity to aid credit creation.

In a nutshell, while there are encouraging signs of recovery, it is not entirely clear how things will pan out and that is why RBI continues to be in a wait-and-watch mode. Ideally, as the economy recovers and supply lines are restored, retail inflation should ease, but everything depends on the rate of Covid-19 infections coming down. If that goes up again, for any reason, then all bets are off.

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Apart from the monetary policy review, the RBI also released its second Monetary Policy Report of 2020. The MPRs are released twice each year — once in April and again in October — and provide a comprehensive round-up of the state of the economy.

Here are five charts from the October edition that stood out.

rbi, reserve bank of india, rbi's mpc, Monetary Policy Committee, monetary policy report, indian express Chart 1

CHART 1 shows what professional forecasters, polled in the September 2020 round of the Reserve Bank’s survey, expected India’s real GDP growth will be going forward. The sharp pick up in the first quarter of the next financial year is driven by the base effect — thanks to a sharp, almost 24% contraction in GDP in Q1 of the current financial year.

rbi, reserve bank of india, rbi's mpc, Monetary Policy Committee, monetary policy report, indian express Chart 2

CHART 2 maps the consumer confidence both current and what consumers expect a year from now. While the current situation index fell to an all-time low in September, for the year ahead, consumer confidence improved in the September 2020 round, “driven by improved sentiments on the general economic situation, the employment scenario and income”.

rbi, reserve bank of india, rbi's mpc, Monetary Policy Committee, monetary policy report, indian express Chart 3

CHART 3 maps the sentiment on the business side and here the story is slightly better. RBI’s Industrial Outlook Survey reflects optimism as the expectations (blue line) for the quarter ahead came back into the expansion zone (above 100).

rbi, reserve bank of india, rbi's mpc, Monetary Policy Committee, monetary policy report, indian express Chart 4

CHART 4 underscores the massive difference between domestic and international fuel prices. RBI Governor Shaktikanta Das has in the past expressed his concern about the role of such high domestic fuel prices (thanks essentially due to high taxation by the central government) in pushing up retail inflation. High retail inflation has been the main reason why RBI has not been able to cut interest rates further.

rbi, reserve bank of india, rbi's mpc, Monetary Policy Committee, monetary policy report, indian express Chart 5 and 6

CHART 5 and 6 show the state of India’s housing industry. The pandemic has simply exacerbated the trend of fewer units being sold and fewer new units being launched. It is largely reflective of two things — one, the regulatory and funding challenges in the housing industry and two, a dip in consumer demand.

Opinion| Recovery and its discontents

As a result, the overall price index (red dotted line in the last chart) has also trended down. The only exception during the post-Covid phase has been the Bengaluru market, where prices shot up in Q1.

In the coming week, the discussion could be dominated by the choice of the latest Nobel prize winner in economics. The decision is likely to be made public on Monday. Two of last year’s winners — Abhijit Banerjee and Esther Duflo — had a huge India connection.

In a year when economies around the world have been facing one of their toughest challenges and decision-makers have continually struggled to find the right policy tools to address the demand as well as the supply shocks, it would be interesting to see who is chosen for the top honour.

Stay safe.

Udit

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