MPC chose loose policy to nurse growth, felt inflation wasn't demand-driven

Loss in momentum of activity could be temporary and restricted to the first quarter of FY22, RBI governor Shaktikanta Das is quoted to have said in minutes of MPC meetings

The six-member monetary policy committee (MPC) felt it was imperative to continue with a loose monetary policy to support growth, as the second wave of the pandemic turned out to be more severe than expected.

The wave, however, largely impacted the consumer demand sentiment, while economic activities continued due to better containment efforts, and supply chains adjusting well to constraints.

“Overall, it is expected that the loss in momentum of activity could be temporary and restricted to the first quarter of 2021-22,” said Reserve Bank of India (RBI) governor Shaktikanta Das, edited minutes of the MPC meetings showed.  

Focus on revival and sustenance of growth was the most “desirable policy option while of course remaining watchful of the inflation trajectory,” the RBI governor said.

Nevertheless, the second wave of Covid-19 has “altered the near-term outlook, and policy support from all sides – fiscal, monetary and sectoral – is required to nurture recovery and expedite return to normalcy," governor Das said, adding the continuation of monetary measures to support the process was needed to make economic recovery durable.

The six-member MPC unanimously decided to keep the policy repo rate unchanged and carry on with the accommodative stance for as long as necessary for durable growth to come.  

RBI deputy governor Michael Patra said supply conditions remained relatively resilient in the second wave, “but aggregate demand barring net exports has been dented and needs counter-pandemic policy support.” Even the turnaround in net exports remained fragile and heavily dependent on vaccination.  

While the MPC has created the necessary conditions for supporting growth, "the onus is on the Reserve Bank to operationalise the MPC’s guidance on an ongoing basis by ensuring congenial financial conditions across the system as well as for specific sectors, instruments and institutions,” Patra said,

Executive director in charge of the monetary policy department Mridul K Saggar said if the economy does expand by 9.5 per cent this year, the output level in 2021-22 will be just 1.6 per cent higher than in the pre-pandemic year 2019-20. Besides, the impact on the informal sector could be higher than anticipated. Therefore, the policy support cannot be pulled out.

"However, while monetary and fiscal policies can lend counter-cyclical support, a sustained revival will ultimately depend on health policies and how the limited fiscal space is used to augment potential output by tagging spending to capex and structural reforms,” Saggar said.

Retail inflation, Saggar observed, was not yet demand-driven “and to accept output sacrifice at this stage may not be the best policy choice.”

External members also said the demand hit would be limited, but they worried about rising inflationary expectations getting entrenched going forward.

“While data on the impact of the second wave of the pandemic is limited, qualitative data emerging from the surveys of households and enterprises suggest a significant dent in the consumer and business sentiments,” said Shashanka Bhide.

While the human cost was incalculable, the economic cost, however, was likely to be limited, according to Ashima Goyal. She expected vaccination in large cities and for corporations to reach a critical mass by July-August, leading to a rapid normalization. The second wave peak in rural areas was in the slack season, and sowing is likely to be normal with a good monsoon. Migrant labour has also become available for work.

However, in times of such uncertainty, “expectations and forecasts are less reliable,” and the MPC should wait for data on actual outcomes.

"Over-reaction has to be avoided to minimize risks if expectations prove incorrect. Adjustment, therefore, has to be gradual but not too gradual as monetary policy acts with long lags," Goyal said.

The US exit from stimulus can provoke some outflows from emerging markets, but “India has the reserves to suit its interest rate policy to its domestic cycle instead of being forced to follow the US cycle," Goyal said.

Jayanth Varma said inflation was not driven by domestic demand, but by supply-side factors including the global surge in commodity prices.

“This could change as the recovery gathers steam, and the MPC must be sensitive to the risk that inflation expectations could become entrenched if inflation remains elevated for too long," Varma said.