MPC minutes: Omicron may derail ongoing demand recovery, says RBI Governor

'Need to remain vigilant to incipient cost-push pressures to inflation as well as to uncertainty imparted by Omicron. Its implication for inflation, going forward, are two-fold,' says Shaktikanta Das

RBI Governor Shaktikanta Das said that Indian economy is facing several headwinds from global factors and that Omicron may derail ongoing demand recovery, showed MPC minutes released by the central bank on Wednesday.

The Monetary Policy Committee (MPC) on December 8 had unanimously voted for status quo on policy rates for the ninth consecutive time. The meeting was conducted soon after the latest Omicron variant of coronavirus started spreading across the globe and most members said they would prefer to wait and see how the situation unfolds before deciding on the future course of monetary policy.

As per the minutes, Das said there was growing uncertainty regarding the evolving global macroeconomic outlook.

On the domestic front, even as the prospects for economic activity are improving, there is still a slack with key drivers like private consumption remaining well below their pre-pandemic levels, he said.

"The Indian economy is facing several headwinds emanating from global factors – some old ones getting prolonged compared with the initial assessment, coupled with new ones. The supply disruptions and other bottlenecks which were earlier anticipated to resolve by end of this year have gained additional shelf life stretching into 2022," said Das during the December 6-8 meeting.

Global trade, after rebounding strongly in the first half of 2021, is losing momentum on the back of stretched supply chain and logistics issues, shortages of key components and slowdown in key regions. The emergence of the Omicron variant may cast some shadow on the momentum of contact-intensive services that were just showing signs of recovery in recent months. The threat of Omicron is also imparting additional volatility to the financial markets, added Das.

While the Indian economy is on its way to achieve the projected growth of 9.5 per cent in 2021-22, there are still significant areas of concern. Private consumption – the mainstay of aggregate demand with a share of around 55 per cent – is languishing below its level recorded two years ago, suggesting that we still have a distance to go in nurturing a more durable recovery, the Governor said.

Private sector capex remains sluggish even though pre-conditions for its acceleration have been engendered by increasing capacity utilisation, deleveraging of balance sheets and improved profitability of corporates, said Das.  

"Given these uncertainties, continued policy support is warranted for a durable, broad-based and self-sustaining rebound, especially to nurture revival in sectors which are lagging and to safeguard those which are exposed to the evolving headwinds," the Governor said.

Das also touched upon the Omicron variant of coronavirus and the impact it could have if it leads to a spike in cases.

"Going forward, the heavy rainfalls in November are likely to keep vegetables prices elevated in the near-term; however, prices thereafter are expected to register seasonal declines on fresh winter arrivals. Retail selling prices of fuel eased somewhat in early November with reduction in excise duty and VAT on petrol and diesel, which should lead to a durable reduction in inflation. Looking ahead, inflation is expected to moderate to 5.0 per cent in H1 of next financial year, remaining well within the tolerance band.

"We, however, need to remain vigilant to incipient cost-push pressures to inflation as well as to the uncertainty imparted by Omicron. Its implication for inflation, going forward, are two-fold. First, increase in restrictions, if any, on activity and commerce to stymie COVID19 spread could translate to continuing supply chain and logistics disruptions. Second, if the Omicron variant results in the onset of new waves of infection globally, this could derail the ongoing demand recovery. On the whole, at this stage it is too premature to gauge as to how the effects of the Omicron variant would pan out in the weeks and months ahead in terms of its effect on growth and inflation," added Das.

MPC member and RBI Deputy Governor Michael Debabrata Patra too expressed concerns on the spread of the new variant of coronavirus, saying "suddenly, the global outlook has darkened".

Elevated levels of inflation will persist until second half of 2022 as also predicted by the IMF, whether we like it or not, but not longer, wrote Patra.

"By the projections, inflation in India will peak in the last quarter of this year and from there, it will moderate," he said.

Patra said, "The Indian economy has been treading a trajectory that diverges from the global situation. Bank credit is picking up, tax revenues are buoyant, exports are growing robustly and the current account balance is set to swing into a deficit on the back of strong import demand, but there are limits to decoupling. There are vulnerabilities too. The level of GDP in Q2FY22 is barely at the so-called pre-pandemic level of Q2FY20, which itself grew at the slowest pace in 6 years preceding it."

Consumption spending is held back by households hesitant to incur discretionary expenditure. Private investment remains timid and is yet to participate in the recovery. Contact-intensive services are still convalescing from the wounds of the pandemic. In November, several high frequency indicators have slowed, suggesting that the second half of 2021-22 may not be the same as the first half and moderation in the recovery could set in, added Patra.

"As countries race to contain Omicron with travel restraints and new quarantine and social distancing measures, the global recovery and the inflation outlook are at risk again," he said.

All MPC members, -- Shashanka Bhide, Ashima Goyal, Mridul K. Saggar, Michael Debabrata Patra and Shaktikanta Das, except Jayanth R Varma, voted to continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Most members raised concerns with regards to the high core inflation in recent months but executive director and Saggar wrote that one month's data suggesting strong growth and inflation momentum is not sufficient to change rate cycles or policy stance.

"This, however, does not mean status quo. Central bank has an armoury of tools to calibrate monetary and financial conditions. The Pascal's principle for transmission of fluid pressures very much holds and appropriate liquidity levels are key to monetary adjustment at this stage," he added.

Varma had expressed reservations on this part of the MPC resolution, the minutes said.

Saggar said MPC can tighten stance when "it is clear that demand revival has acquired resilience".

"Small moves towards policy normalisation may be sufficient now and one can decide to shift to a tightening monetarypolicy cycle at a point when it is clear that demand revival has acquired resilience and pandemic risks to growth have diminished or alternatively if inflation diffusion persists in near months which then can result in inflation getting generalised and persist next year, especially if inflation expectations get unanchored," said Saggar.

Goyal said RBI policies targeting liquidity at stressed sectors must continue.

"There is steady progress in fine-tuning and control of liquidity since early this year. Since the share of VRRR has gone up, the weighted average reverse repo rate is higher and some other short rates have risen. Additions to durable liquidity have stopped. But the next step is to decrease excess durable liquidity itself. Some of this will be absorbed as growth rises," said Goyal. 

Bhide said output levels of the various sectors in Q2FY22 are above Q2FY21 and MPC needs to ensure inflation remains within the target going forward.

At a broad level, output levels of the various sectors in Q2FY22 measured by GVA at constant prices are above Q2FY21. But there is also unevenness in growth performance reflecting sectoral and other structural variations in the adjustments taking place in the economy in the ongoing recovery process. In the case of ‘Trade, hotels, transportation, communications and broadcasting services’, which had a share of 20.3% in total GVA in 2019-20, the gap from Q2FY20 is 9.2%. In general, the pace of output recovery in contact-intensive sectors is likely to be affected by both supply side constraints and weak demand, conditions, which may abate only with further relief from the pandemic," said Bhide.