June MPC key to assess future policy bias

It is nearly certain that the monetary policy committee (MPC) will hold the key policy rates unchanged in their upcoming meeting later this week. For ensuring better flow of credit to various segments of the economy, policy makers have recently acted between scheduled MPC meetings and may continue to do so whenever needed. Thus, expectation of immediate action related to monetary policy, or better credit flow, is relatively limited in the current policy.

Nonetheless, one feels that the June MPC meeting is one of the most interesting and crucial ones in recent months. It comes against the backdrop of renewed headwinds for growth recovery and possibilities of material breach in the RBI’S “upper tolerance band” for inflation prints in the coming months, despite markedly weak domestic demand. Against this backdrop, the June policy may throw light on the MPC’S bias for monetary policy in the future. One clearly sees the need for the MPC to continue supporting growth in coming months, looking through supply side-driven inflation. Still, it remains critical how emphatically the RBI conveys the same and whether the new MPC under Governor Das prefers to retain more flexibility in this regard, than in the past.

Over the last couple of months, there have been major unfavourable developments with regards to both growth and inflation. The second wave of the pandemic will likely also result in medium-term dent in business and consumer confidence. Further worsening cannot be ruled out. Overall, the second wave may reduce India’s FY21-22 growth prospects by 2-3 percentage points.

While a high single-digit growth in FY21-22 may not appear that bad at the first glance, one must recognize that, say, 8 per cent growth in FY21-22 over a 7.3 per cent contraction in the previous year would mean that gross value addition in the economy during FY21-22 may hover just around that during FY1920, which implies effectively zero growth for two consecutive years. Also, it is felt,as also suggested by the IMF recently, the pandemic might cause a larger dent in India’s longterm growth prospects than most of its peers. On the other hand, India seems to have little control over the current phase of rising inflation prints. Globally, commodity prices are rising reflecting improving growth prospects and persisting supply disruptions. At home, the second wave has disrupted supply chain logistics. The latest WPI inflation print of 10.5 per cent is highest in over a decade. Retail inflation will also likely breach the RBI’S “upper tolerance band” of 6 per cent several times during the year, and at times, by wide margins.

While the macro backdrop is fraught with challenges, the strong contra-cyclical stance and deft use of unconventional monetary policy tools since the break-out of the pandemic provide confidence. Despite the unavoidable wider fiscal deficit and larger government borrowing, one expects continued strong fiscal-monetary co-ordination to cushion the overall interest rate spectrum, apart from effective channeling of credit flows. Finally, on this note, one expects even greater policy empathy for the lower end of India’s economic pyramid (eg, poor households, MSMES).