Covid blow to economy may take years to heal, feels MPC

The six-member Monetary Policy Committee (MPC) was deeply concerned about the economic wreck that the Covid-19 pandemic has caused, and said it “would take years” for the economy to repair, show the minutes of the meeting released by the Reserve Bank of India (RBI) on Friday. RBI Governor Shaktikanta Das warned of a severe impact on the economy due to the two months of lockdown, a collapse in demand, as gauged by the high frequency indicators, and a fall in private consumption and investment, as seen through tepid bank credit growth. Demand concerns will continue to weigh heavily on economic activity for some time to come, said Das. But he was optimistic about a revival in rural economy due to a good harvest. Other members were also concerned about the hit to consumer sentiment, demand, and private investment.

The six-member Monetary Policy Committee (MPC) was deeply concerned about the economic wreck that the Covid-19 pandemic has caused, and said it “would take years” for the economy to repair, show minutes of the meeting released by the Reserve Bank of India (RBI) on Friday.

RBI Governor Shaktikanta Das warned of a severe impact on the economy due to the two months of lockdown, a collapse in demand, as gauged by the high frequency indicators, and a fall in private consumption and investment, as seen through tepid bank credit growth. Demand concerns will continue to weigh heavily on economic activity for some time to come, said Das. But he was optimistic about a revival in rural economy due to a good harvest.

“In assessing the magnitude of policy space, it is important to take into account the weak growth momentum, the need for prioritising growth in view of the less risky inflation outlook, and the need to assure benign financial conditions ahead of the recovery taking hold so that confidence is sustained,” Das said.

Other members were also concerned about the hit to consumer sentiment, demand, and private investment.

“My view is that the damage is so deep and extensive that India’s potential output has been pushed down, and it will take years to repair,” said Deputy Governor Michael Debabrata Patra during MPC deliberations that led to a 40 basis-point out of turn repo rate cut on May 22.

Executive director in charge of monetary policy Janak Raj flagged the collapse of demand in private investment.

“Within aggregate demand, while private consumption is likely to slow down from the pre-covid levels, what worries me more is investment demand, which is likely to be impacted severely for a variety of reasons,” Raj said.

Excess capacity has been created in many sectors, which — combined with huge uncertainty about future demand, both domestic and external — is likely to hamper new investments in the private sector. Financing of investment activity will also be a challenge due to weak balance sheets.

Also, the focus of government spending, both by the Centre and states, will be on revenue expenditure than on capital expenditure, he said.

Therefore, investment activity, which contracted in the last two quarters, “is expected to be severely hit going forward”.

He expected economic activity to contract in 2020-21. While supply lines are likely to be restored as lockdown is relaxed, “demand would take far longer to revive to pre-covid levels,” Raj said, adding, the fall in investment demand “may be a huge drag on economic activity in the near future with attendant implications for potential growth”.

External member Ravindra Dholakia said India’s real interest rates are still very high at around 1.2 to 1.6 per cent. “I believe the policy rate needs to be kept positive but not so high under the present conditions,” Dholakia said, rooting for a 40 basis-point rate cut.

According to him, once the situation returns to normal and the fiscal and monetary boost measures start generating impacts, the economy may require some further boost, Dholakia said.

The RBI governor had said in his media address that there would be room for more rate cuts in the future, contingent on inflation coming under control. The central bank had hoped that inflation would start tapering off from the end of the calendar year. But the RBI did not give any guidance on inflation and growth due to deficient data.

External member Pami Dua talked about the “grim prognosis for the economy.” She cited collapse in industrial and manufacturing numbers, passenger vehicle sales, standstill in economic activities due to lockdown, and fall in purchasing manager index.

Dua sounded caution over the findings of the consumer confidence survey conducted by the RBI in May, which painted a “grim picture, showing that the overall Current Situation Index is at a historic low, while the Future Expectations Index reflects high pessimism for the year ahead. Thus, consumer sentiment has plunged to abysmally low levels.”

Another external member Chetan Ghate, who was also the only member who voted for a 25 basis-point cut, as he was concerned about inflation. “It is not entirely clear to me that Covid-19 constitutes a large disinflationary shock. Inflationary pressures fall with economic slack (the output gap), but rise with expected future inflation and factors related to production costs,” Ghate said.

In this context, Ghate cited the inflationary expectations survey, which has spiked by 190 and 120 basis points for three months and one-year ahead inflation, respectively. “This is worrisome. I continue to be concerned about declining market arrivals of food commodities because of Covid-related supply side bottle-necks and their inflationary impact,” Ghate said, adding, when the economy turns to the upside, the recovery in demand will be swift.

“IN ASSESSING THE MAGNITUDE OF POLICY SPACE, IT’S IMPORTANT TO TAKE INTO ACCOUNT THE WEAK GROWTH MOMENTUM, THE NEED FOR PRIORITISING GROWTH, AND THE NEED TO ASSURE BENIGN FINANCIAL CONDITIONS” SHAKTIKANTA DAS, RBI governor

“I BELIEVE THAT THE REAL POLICY RATE NEEDS TO BE KEPT POSITIVE BUT NOT SO HIGH UNDER THE PRESENT CONDITIONS” RAVINDRA DHOLAKIA, External member

“COLLAPSE IN INDUSTRIAL AND MANUFACTURING NUMBERS, VEHICLE SALES AND FALL IN PMI... A GRIM PROGNOSIS FOR THE ECONOMY” PAMI DUA, External member