Finance minister Nirmala Sitharaman hit the ball out of the park with a resounding six. The six pillars of her Budget 2021, which has been a resounding success with the corporate sector and the financial markets, are Health and Wellbeing; Physical & Financial Capital, and Infrastructure; Inclusive Development for Aspirational India; Reinvigorating Human Capital; Innovation and R&D; and finally, Minimum Government and Maximum Governance.

With a massive focus on expenditure, particularly capital expenditure, to generate the much-needed mutiplier effects for various sectors of the economy, Sitharaman’s Budget is being seen as a potential catalyst which can get the economy, reeling under the impact of the Coronavirus pandemic, back on the path to growth. The Economic Survey, presented before the Budget, has also put forward an argument saying there were enough green shoots visible in the economy which point to a V-shaped recovery building up in the economy.

The stimulus, the Survey had argued, needed to be continued to help the economy get back on its feet. The finance minister continued with the Keynesian stimulus line, and how. The Budget pegged expenditure of a hefty ₹34.83 lakh crore for FY22, which includes ₹5.5 lakh crore by way of capital expenditure. The total increase works out to 34.5%, which the FM said was aimed at giving the required push to the economy.

Coming days after this expansionary Budget (where the fiscal deficit for FY22 was pegged at 6.8%), the Reserve Bank of India (RBI) will now unveil its monetary policy on February 5, after the three-day deliberations of its monetary policy committee (MPC) come to an end. Will RBI governor Shaktikanta Das and the MPC opt to support the FM’s steps and continue its accommodative policy? Will RBI do something dramatic, and cut rates to spur growth further?

By all accounts, popular opinion in financial circles seems to be veering to the view that RBI will keep the benchmark repo rate -- the rate at which the central bank lends short-term funds to banks -- unchanged when it announces its policy on February 5. Given the enormous hit the economy has taken during the first two quarters of FY21, contracting 23.9% in the first quarter and 7.5% in the second, most bets are on the RBI keeping the repo rate unchanged while pushing the growth momentum. The accommodative policy which RBI has been maintaining during 2020, supporting the government’s efforts to ameliorate the debilitating impact of the pandemic is, therefore, likely to continue.

Delivering the Nani Palkhivala Memorial Lecture in the middle of January, governor Das explained RBI’s thinking. Outlining the series of steps RBI took during the pandemic, Das said: “Our principal objective during this pandemic period was to support economic activity; and looking back, it is evident that our policies have helped in easing the severity of the economic impact of the pandemic. I would like to unambiguously reiterate that the Reserve Bank remains steadfast to take any further measures, as may be necessary, while at the same time remaining fully committed to maintaining financial stability.” Note the governor’s emphasis on remaining steadfast to taking any further measures.

The FM’s job, indeed, had been made somewhat easier with the RBI steadfastly rooting to get growth back in the system. Now, with the Budget unleashing an aggressive expenditure game plan, RBI would need to ensure monetary policy works in tandem with fiscal policy, even while financial stability is maintained. “We need to support economic revival and growth; we need to preserve financial stability,” governor Das had ended that lecture by saying.

M. Govinda Rao, chief economic advisor at Brickwork Ratings, also appears to support the view that RBI is unlikely to tinker with the repo rate for now, and will leave it unchanged at the current 4%. However, Rao adds in his pre-policy comment: “Considering the threat arising from surplus liquidity on inflation, we expect the RBI to focus on squeezing excess liquidity from the system.”

Rao’s thesis is that RBI will need to suck out excess liquidity from the system in some form, in order to keep inflationary pressures under check even as it continues with an expansionary policy to push growth. Since March 2020, RBI has brought the repo down by a hefty 115 points in all and this has helped in lowering both short-term, and long-term interest rates. Consequently, lower yields have also helped the government’s borrowing costs to remain low so far.

However, the additional government borrowing announced in Budget 2021 will have an impact on interest rates. The government said its revised estimates for FY21 raised borrowings to ₹12.8 lakh crore, up from the Budget estimate of ₹7.8 lakh crore, a 64% increase. For FY22, the government’s market borrowing will be to the tune of ₹12.05 lakh crore.

Rao points out that surplus liquidity assuages the pressures on bond yields, “but keeping excess liquidity in the system for long also exerts inflationary pressures.” He says the recent decline in inflation provides some comfort to the MPC, but upward risks remain which need to be watched since the core inflation has not come down. Besides, there are renewed concerns on rising crude oil prices. The current level of CPI inflation is also higher than the MPC’s median target of 4%, Rao adds.

Meanwhile. Rahul Bajoria, chief econ0mist at Barclays, in a February 3 report also pointed to the fact that the recovery was “intact”, with the fourth successive expansionary reading in India’s services performance managers’ index (PMI), an important indicator of how the services sector is faring. The January services PMI reading was 52.8, higher than the 52.3 recorded in December 2020. A reading of over 50 signifies expansion.

Bajoria also points to some inflationary elements. He says cost inflation, though high, moderated in January, likely due to price discounting strategies adopted by companies. “However, demand normalisation could see a return of pricing power, with producers passing on rising input costs to end-consumers.”

With the number of new Covid-19 cases in control and on the decline, and the vaccine roll-out continuing smoothly, Bajoria feels the economy would grow by 0.4% during the fourth quarter of 2020, rebounding by 9.2% during 2021.

While the economy, by most estimates, seems to be on the mend, RBI will need to continue pushing the growth momentum to ensure the revival does not sputter. However, inflationary pressures are not something the central bank will ignore, or wish away even as it plumps for growth. That will be the balance governor Shaktikanta Das and the RBI MPC will need to strike.

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