On March 27, when Reserve Bank of India (RBI) governor Shaktikanta Das announced the bazooka measures of rate cuts and moratorium after an off-cycle Monetary Policy Committee (MPC) meeting in view of the Covid-19 crisis, ‘Covid-19’ found 22 mentions, and ‘growth’, ‘GDP’, and ‘inflation’ found 13, 3 and 9 mentions each. Yet no projections pertaining to the latter terms were given. Das explained that the situation was one of heightened volatility and unprecedented uncertainty. “Everything hinges on the depth of the Covid-19 outbreak, its spread and its duration.”

Just 13 days after the March 27 MPC review announcement, the half-yearly monetary policy report (MPR) released by the central bank highlights that the global macroeconomic outlook is overcast with the Covid-19 pandemic, with massive dislocations in global production, supply chains, trade and tourism. The RBI also added that financial markets across the world are experiencing extreme volatility; global commodity prices, especially of crude oil, have declined sharply.

The RBI said that Covid-19 would impact economic activity in India directly due to lockdowns, and through second round effects operating through global trade and growth.

The RBI said that India has not been spared from the exponential spread of Covid-19 with more than 4,700 cases as of April 7. Fallouts from the lockdown and the severe slowdown in global trade and growth have started to tell on domestic financial markets. The RBI said that these effects and their interactions would inevitably accentuate the growth slowdown, which started in Q1-FY19 and continued through H2-FY20.

“Meanwhile, headline inflation stayed above the upper tolerance band of the inflation target band during December 2019-February 2020, led by a spike in vegetable prices,” said RBI. While inflation has peaked and vegetable prices are on the ebb, the RBI is of the view that the impact of Covid-19 on inflation is ambiguous when compared to that on growth, with a possible decline in prices of food items being offset by potential cost-push increases in prices of non-food items due to supply disruptions.

The RBI also highlighted that since its last MPR in October last year, the evolution of key macroeconomic and financial variables warrants revisions in the baseline assumptions.

First, international crude oil prices (Indian basket) have fluctuated in a wide range since the October 2019 MPR. These prices initially increased during late December 2019 and early January 2020 to around $70 per barrel, triggered by US-Iran tensions. They subsequently softened, however, to reach $51 by early March in anticipation of lower global demand following the outbreak of Covid-19 and its rapid geographical spread.

Brent prices crashed to $32 on March 9, following Saudi Arabia’s decision to cut prices and increase production over the failure to reach an agreement with Russia on production cuts. Brent fell further to $23 on March 30, while U.S. crude prices dipped briefly below $20. Later, Brent rebounded to $34 per barrel on April 3.

“Given the current demand-supply assessment, the baseline scenario assumes crude oil prices (Indian basket) to average around $35 per barrel during FY21. In the previous MPR, the RBI had envisaged the crude oil at $62.6 per barrel during second half of FY20. The absolute decline of $27.6 per barrel works out to 44.09% in percentage terms.

The second assumption change is around the nominal exchange rate of the Indian rupee versus the US dollar. This exchange rate exhibited sizable two-way movements during October-December 2019. “The rupee came under intensified and sustained depreciation pressures beginning mid-January, reflecting a generalised weakening of emerging market currencies amidst flights to safety,” the RBI said.

“Accordingly, the baseline assumes an average of ₹75 per US dollar to reflect these recent developments,” the RBI added. As against the previous MPR assumption of ₹71.3 per dollar, the latest revision factors in a depreciation of 5.19%.

The third factor revolves around the growth outlook. The central bank pointed out that even though uncertainties relating to US-China trade relations and Brexit have receded, the Covid-19 pandemic has taken over. The RBI highlighted that the World Trade Organisation’s (WTO) goods and services trade barometers indicate that world trade volume growth weakened in early 2020; it is expected to be debilitated further by the adverse impact of Covid-19.

“The IMF expects that the contraction in global output in 2020 could be as bad as or worse than in 2009,” the RBI noted. “The depth of the recession and the pace of recovery in 2021 would depend on the speed of containment of the pandemic and the efficacy of monetary and fiscal policy actions by various countries.” The slowdown could be more protracted in dire scenarios in which the duration of Covid-19 extends longer.

The RBI also quoted the Organisation for Economic Co-operation and Development (OECD) estimates which suggest that annual GDP growth could be lower by up to 2% for each month in which strict containment measures continue. “If the shutdown continues for three months with no offsetting factors, annual GDP growth could be between 4-6% lower than it otherwise might have been,” the RBI added quoting the OECD projections.

Specifically, from the October MPR where monsoon was assumed to be 10% above the long period average for 2019, the latest assumption is normal monsoon for 2020. On the fiscal deficit front, the previous MPR had assumed it to remain with the budget estimates for FY20; 3.3% for the centre, and 5.9% for on combined basis. In the latest MPR, RBI anticipates the fiscal deficit to remain within the budgeted estimates for FY21; 3.5% for the centre, and 6.1% on combined basis.

On inflation front, looking ahead, the balance of inflation risks is slanted to the downside. The RBI believes that food prices may soften under the beneficial effects of the record food grain and horticulture production, at least till the onset of the usual summer uptick. Also, the collapse in crude prices should work towards easing inflationary pressures, depending on the level of the pass-through to retail prices.

“All these signals are, however, heavily conditioned by the depth, spread and duration of Covid-19 and shifts in any of these characteristics of the pandemic can produce drastic changes in the outlook,” the RBI warned. “In these conditions, forecasts are hazardous as they are subject to large revisions with every incoming data on the pandemic.”

However, the RBI Act enjoins the central bank to publish and explain in the MPR, inter alia, forecasts of inflation for 6-18 months from the date of its publication. Therefore, taking into account initial conditions, signals from forward-looking surveys and estimates from time series and structural models, CPI inflation is tentatively projected to ease from 4.8% in Q1 of FY21 to 4.4% in Q2, 2.7% in Q3 and 2.4% in Q4 “with the caveat that in the prevailing high uncertainty, aggregate demand may weaken further than currently anticipated and ease core inflation further, while supply bottlenecks could exacerbate pressures more than expected.”

However, the RBI also highlighted that a quick containment of Covid-19 could lead to faster recovery and, therefore, firmer inflation pressures. Given the lockdown, the compilation of the CPI for March and the following few months by the National Statistical Office (NSO) could also become challenging, in the central bank’s view. “For 2021-22 (FY22), assuming a normal monsoon and no major exogenous or policy shocks, structural model estimates indicate that inflation could move in a range of 3.6-3.8%,” RBI added.

And, on the GDP growth outlook, the RBI said that prior to the outbreak of Covid-19, the outlook for FY21 was looking up. In RBI’s views, first, the bumper rabi harvest and higher food prices during FY20 provided conducive conditions for the strengthening of rural demand.

Second, the transmission of past reductions in the policy rate to bank lending rates has been improving, with favorable implications for both consumption and investment demand.

Third, reductions in the goods and services tax (GST) rates, corporate tax rate cuts in September 2019 and measures to boost rural and infrastructure spending were directed at boosting domestic demand more generally. “The Covid-19 pandemic has drastically altered this outlook,” said RBI.

The RBI firmly believes that Covid-19, the accompanying lockdowns, and the expected contraction in global output in 2020 weigh heavily on the growth outlook. “The actual outturn would depend upon the speed with which the outbreak is contained and economic activity returns to normalcy,” said the RBI.

Significant monetary and liquidity measures taken by the central bank and fiscal measures by the government would mitigate the adverse impact on domestic demand and help spur economic activity once normalcy is restored, the RBI hopes. While risks around the inflation projections appear balanced at this juncture and the tentative outlook is benign relative to recent history “… Covid-19 hangs over the future, like a spectre.”

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