RBI assessment of Covid-19 second wave

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  RBI assessment of Covid-19 second wave

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Read more on - Polity | Economy | Schemes | S&T | Environment

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• The story: India was hit by a shockingly strong second coronavirus wave in March-April 2021. The second wave of Covid infections and its impact on growth loomed large on the minds of the six MPC members, as per minutes of the meetings released by the RBI. (MPC - Monetary Policy Committee)
• Details of the minutes:

1. Forward guidance - MPC minutes show one member saw little merit in continuing with central bank's forward guidance. Jayanth R Varma, external MPC member, said RBI’s forward guidance has failed to bring down yields and that the practice can be stopped.
2. The monetary policy committee (MPC) members were also in favour of engaging with the bond market on yields. The RBI had announced a Rs 1 trillion bond buying from the secondary market in the first quarter. That is what a QE is (quantitative easing).
3. The MPC decided to keep the policy repo rate unchanged and the stance at accommodative “for as long as necessary to sustain growth, while ensuring that inflation remains within the target”.
4. The minutes showed that even as the RBI kept its growth forecast for the fiscal year unchanged at 10.5 per cent, most members were not sure how the second Covid wave would play out. Rapidly rising cases is the single biggest challenge to ongoing recovery in the Indian economy, as per RBI Governor Shaktikanta Das.

• Kya se kya ho gaya: The economy was evolving on the lines of the February 2021 MPC resolution, with improving demand conditions, investment enhancing measures by the government and external demand imparting an upside to growth prospects, but the recent jump in infections and its impact on economic activity changed the dyanmics. The “need of the hour” was to “effectively secure the economic recovery underway so that it becomes broad-based and durable”, Das said, adding, “the RBI would take all steps to ensure orderly conditions in the financial markets and to preserve financial stability.”

1. Deputy Governor Michael Patra said the recent rise in inflation could be looked through while the focus could remain “on reviving the economy on a path of strong and sustainable growth. An integral part of this approach would be to insulate domestic financial markets from global spillovers and volatility so that congenial financial conditions continue to support growth.”
2. RBI’s Executive Director Mridul K Saggar said the economic recovery could come under risk if the new wave of infections was not flattened soon, especially as “monetary and fiscal policies have already used most of their space to considerably limit loss of economic capital”. 
3. Expansion of policy toolkits, though, could still afford additional comfort. The rise in infection could delay full normalisation by a quarter or two. Health policies have become the first line of defence, while the “monetary and fiscal policies can only play second fiddle”.

• Growth projections: The baseline projection in growth of 10.5 per cent was on account of an “all-time low base.” The “realisation of the projected growth will translate to only a meagre average growth rate of 0.85 per cent in two years following 2019-20”. This provided justification for the monetary policy’s continued support to growth, Saggar said, adding both consumption and investment nee­ded to be stimulated. Capacity utilisation rate at 66.6 per cent was well below the long-term average of 73.6 per cent. 

1. The pace of recovery of output needs to offset the negative impact of the Covid-19 shock to the economy in terms of growth in income, and employment will be substantial and sustained over many years.
2. The easy monetary policy has helped sustain economic activities and recovery, and that such policy environment would be needed to strengthen and broaden the ongoing recovery process.

• Others' experience: The second wave in many countries has been “sharp but short”, as per Ashima Goyal, MPC member. The effect on growth could be marginal if complete lockdowns and bans on interstate movement are avoided. The base-effect facilitated growth rate of above 10 per cent “does not imply sustained growth at potential.”  The growth rate would “barely take us to the level we had reached in 2019. We have to also make up for lost time; alleviate widespread job loss and income stress.”
• Problem with yield curve: MPC member Jayanth R Varma was more forthcoming, and said RBI’s forward guidance has “failed to flatten the yield curve”, and he saw “little merit in persisting with it anymore”. It was not prudent to “repose excessive faith in forecasts. Instead, the MPC must have the agility and flexibility to respond rapidly and adequately to whatever surprises new data may bring in future. Time based guidance is inconsistent with this imperative.”
• Summary: Overall, the RBI MPC has now realised that the vicious strength of the second coronavirus wave will take a strong toll on the positive momentum of the Indian economy in 2021-22. What tools the RBI may now adopt, remains to be seen.
• Knowledge centre: 

1. MPC - The RBI's Monetary Policy Committee (MPC) of six members was first constituted in 2016 (for 5 years) by the Central Government under Section 45ZB, and determines the policy interest rate required to achieve the inflation target. The Monetary Policy Department (MPD) assists the MPC in formulating the monetary policy. Views of key stakeholders in the economy, and analytical work of the Reserve Bank contribute to the process for arriving at the decision on the policy repo rate. The Financial Market Committee (FMC) meets daily to review the liquidity conditions so as to ensure that the operating target of monetary policy (weighted average lending rate) is kept close to the policy repo rate. Monetary policy refers to the policy of the central bank with regard to the use of monetary instruments under its control to achieve the goals specified in the Act. The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy. This responsibility is explicitly mandated under the Reserve Bank of India Act, 1934. The flexible inflation targeting (FIT) adopted for 2016-2021  with a CPI-inflation target of 4% +/- 2% is being extended as it is till 2026.
2. Yield Curve - A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity. A rise in bond yields means interest rates in the monetary system have fallen, and the returns for investors (those who invested in bonds and govt securities) have declined. When bond yields rise, the RBI has to offer higher cut-off price/yield to investors during auctions. This means borrowing costs will increase at a time when the government plans to raise money from the market.” In such cases RBI is expected to stabilise yields through open market operations and operation twists. Besides, as government borrowing costs are used as the benchmark for pricing loans to businesses and consumers, any increase in yields will be transmitted to the real economy. The RBI wants the orderly functioning of the yield curve. The objective of the RBI is to eschew volatility in the G-Sec market. The introduction of the secondary market Government Security Acquisition Programme (GSAP) shall help the yields remain range bound and shall be within the RBI’s comfort. There shall be less volatility as now it is clear with RBI introducing GSAP 1.0 in the longer bond 3 years bond.

Read more on - Polity | Economy | Schemes | S&T | Environment

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