RBI April Report finally talks the dreaded "R" word

The report carries a clear word of caution that the lockdown of economic activity could create a situation of economic inertia that could result in economic contraction for at least a couple of quarters.

April 15, 2020 10:31 IST | India Infoline News Service
The Monetary Policy Report (MPR) released by the RBI every six months is generally a routine document. However, the April 2020 report assumes specific significance because the RBI has devoted a complete space to issue cautionary notes about the downside risks of COVID-19. In fact, without saying as much, the central bank has hinted at the “Recession” word for the first time. The RBI narrative appears to be largely loaded on the uncertainty created by the COVID-19 and the subsequent lockdown. The report carries a clear word of caution that the lockdown of economic activity could create a situation of economic inertia that could result in economic contraction for at least a couple of quarters.

Key takeaways from the RBI Monetary Policy Report (MPR)
The theme of the MPR seems to be that the COVID-19 remains the big overhang for the Indian economy. Here are some major takeaways.
  • RBI has pointed out that the COVID-19 and the subsequent slowdown comes at a time when the economy was just showing signs of a pick-up. The markets were giving hints of a gradual pick up in GDP growth to around 5% in FY2020-21 and inflation tapering closer to the 3.2% mark. However, COVID-19 may have sharply changed the growth narrative.
  • The RBI report has warned that the COVID-19 impact on growth will play out at two levels. The first will be the immediate impact where production and purchasing power get constricted due to the lockdown. The second level of growth impact will happen when the global slowdown gets gradually transmitted to India via global trade and demand for services like software and IT.
  • RBI has been quite categorical in its report that the perceived thrust to rural demand would either not happen now or may take a long road to recover. Prior to COVID-19, the building blocks to boosting rural demand were already there. The bumper Rabi (winter) crop had more than compensated for the weak Kharif and the government’s aggressive thrust on rural infrastructure and rural jobs was working. However, the report admits that the massive reverse migration to villages could put tremendous pressure on rural infrastructure. Check the chart below.
High Frequency Indicators show fall in rural discretionary spending
Data Source: RBI Monetary Policy Report
  • There is good news on the inflation front as per the RBI report, but it is still not clear whether falling inflation is really a reason to celebrate. RBI MPR expects the retail inflation to gradually taper from 4.8% in the first quarter of the fiscal to 4.4% in the second quarter and 2.7% and 2.4% in the third and fourth quarters respectively. However, the RBI MPR warns that the weak inflation would be driven less by inflation control measures and more by the economic slowdown leading to lower rural and urban incomes, lower purchasing power and hence lower demand. This weak demand is expected to push inflation lower in the coming quarters but the caveat is that it could be more a case of disinflation (moving towards deflation) than a case of tapering of inflation. Check the cart below for RBI projections.

Lower inflation expectations are indicative of weak demand

Data Source: RBI Monetary Policy Report
  • At a policy level, the RBI has hinted at a liberal monetary and fiscal policy to be adopted by the government and the RBI. Clearly, there is unlikely to be any discussion about inflation control till the time growth stabilizes and factories are able to resume production at normal levels.
Finally, the “R” word has been used in the report
Even with the assumption of substantially weaker oil prices, the RBI has projected an economic contraction.

RBI MPR report April 2020 uses the "R" word
Data Source: RBI Monetary Policy Report
The RBI MPR report has projected an economic contraction in FY21. The fourth quarter GDP growth data that will be announced on May 31, 2020 will give the first indication of the extent of damage caused by the Coronavirus and the subsequent lockdown. As of now, it is still now too clear as to how long the economic lockdown will continue, how much lead time will be required for factories to get back to full capacity and how the economic inertia would play out. But, the fact that the RBI has given a warning of an economic contraction may be an indication enough that apart from the March quarter, even the June quarter and September quarter could see negative growth. As the RBI has rightly admitted, the COVID-19 has drawn a huge cloud over the economic growth prospects and it would be premature to make any assessment at this point of time without looking at the high frequency indicators. It is in this perspective that the “R” word hinted at by the RBI MPR must be seen.

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