RBI’s masked growth and inflation forecasts

The last monetary policy committee (MPC) meeting of the Reserve Bank of India (RBI), on March 27, was an off-schedule one. Given that the central bank follows a calendar, the out-of-turn virtual meet of the MPC members was unusual. The compelling reason for the preponed meeting was unprecedented: the Covid-19 pandemic.

Another uncommon development after the meeting was the fact that the RBI did not reveal the MPC’s projections for inflation and GDP growth for the coming quarters. RBI governor Shaktikanta Das had said: “Given the heightened volatility, unprecedented uncertainty and extremely fluid state of affairs, projections of growth and inflation would be heavily contingent on the intensity, spread, and duration of Covid-19.”

Two weeks later, on April 9, the central released its six-monthly Monetary Policy Report (MPR), and again refrained from commenting on the GDP growth and inflation projections. “The highly fluid circumstances in which incoming data produce shifts in the outlook for growth on a daily basis, forecasts for real GDP growth in India are not provided here, awaiting a clear fix on the intensity, spread and duration of Covid-19,” the RBI said in the report.

Though domestic GDP forecasts were missing in both cases, the MPR did point at the Organisation for Economic Cooperation and Development’s ( OECD) projection of the decline in global growth for 2020 in the range of 0.5-1.5%. Further, RBI also quoted International Monetary Fund’s (IMF) latest assessment, which is that global growth during 2020 could be negative compared to 2.9% in 2019, which itself was a decadal low.

While the official projections were missing, the RBI’s MPW used alternative scenarios to evaluate the possible impact of the global slowdown on India’s growth and inflation using the Quarterly Projection Model (QPM)–a semi-structural, forward-looking, open economy, calibrated, gap model in the New Keynesian tradition that provides an internally consistent analysis of various feedback mechanisms.

The RBI used QPM using two different scenarios–one assuming 2020’s global growth to be 3% lower than 2019, and the second scenario assumed that the pandemic outbreak is contained faster and the loss of global output growth in 2020 to be only 1.5% relative to 2019.

In RBI’s assessment, lower global output and demand can impact the Indian economy through a variety of channels. First, it can affect exports adversely, leading to lower domestic demand, growth and inflation.

Second, international crude oil and other commodity prices have already softened sharply amidst high volatility and India, being a net importer, can benefit from the lower commodity prices. And, finally, heightened global financial market volatility can feed into domestic financial markets and impact both growth and inflation.

And, the RBI said that the QPM captures all these channels, and the model’s simulations suggest that, on account of global factors, domestic growth could be lower, at its peak, by 180 basis points (-1.8%) in scenario one and by 80 basis points (-0.80%) in scenario two. “Inflation could be lower by 40-100 basis points (-0.4% to 1%) at its peak under the two scenarios,” RBI added.

The Covid-19 pandemic poses upside and downside risks to the baseline assumptions and outlook. The Indian rupee (INR)-dollar exchange rate has moved in both directions in recent months. The RBI warns that renewed bouts of global financial market volatility caused by the uncertainty of macroeconomic impact of Covid-19, as in February-March 2020, could exert pressure on INR.

“Should the INR depreciate by 5% from the baseline, inflation could edge up by around 20 basis points (+0.20%) while GDP growth could be higher by around 15 basis points (+0.15%) through increased net exports,” the RBI highlighted. “In contrast, should Covid-19 normalise quickly, strong capital flows could revive, an appreciation of the INR by 5% could moderate inflation by around 20 basis points (-0.20%) and GDP growth by around 15 basis points (-0.15%) versus the baseline.”

Exchange rate apart, on the global crude oil price front, should the Indian basket prices increase by 10% above the baseline assumption, inflation could be higher by 20 basis points (+0.20%) and growth could be weaker by around 15 basis points (-0.15%). If Covid-19 were to persist longer, global economic activity and demand for crude oil could fall further in an environment of sustained oversupply due to Saudi Arabia’s decision to enhance production, the RBI warned.

Should the Indian basket crude price fall by 10% compared to the baseline, inflation could ease by up to 20 basis points (-.020%), and growth higher by up to 15 basis points (+0.15%), depending upon the extent of pass-through to domestic product prices.

Finally, food inflation will also have its say on the scenarios. The RBI highlighted that the baseline path assumes vegetable prices to fall rapidly in response to arrivals of rabi harvests and a normal south-west monsoon during 2020, which is supported by early signals of likely ENSO (El Nino-Southern Oscillation) neutral conditions.

Additionally, the RBI opines that adequate buffer stocks in cereals and a good rabi harvest (2019 season) could soften food inflation more than anticipated and pull down headline inflation by 50 basis points (-0.50%) below the baseline. On the other hand, a deficient or spatially skewed southwest monsoon, and an unexpected hardening of prices of non-vegetable food items could push headline inflation above the baseline by around 50 basis points (0.50%) in FY21.

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

However, the central bank optimistically believes that its significant monetary and liquidity measures, and the fiscal measures taken by the government would mitigate the adverse impact on domestic demand and help spur economic activity once normalcy is restored.