Vaccination and the state of the economy
The RBI, in its monthly bulletin has brough out that in India and across the world, the key to a rapid economic recovery in FY22 would lie in how quickly the people are inoculated and hopefully the vaccination actually works. The RBI has warned that the biggest risk to the bond markets comes from short sellers who are pushing prices lower and yields higher.
RBI has specifically spoken about the urgent need to resume high GDP growth at around 12% in FY22 and 7-8% after that. The two positive cues for the future growth of the GDP has come from a sharp recovery in the capex cycle as well as better-than-expected corporate results in the second and third quarters of FY21. While headline inflation has shown signs of tapering, core inflation remains close to 5.9% and IIP is yet to show positive traction. But the moral of the RBI story is that it would eventually boil down to how quickly and effectively India manages to inoculate large swathes of its population.
Unconventional monetary policy in FY21
When the US went ahead and cut Fed rates close to zero at the start of the pandemic, the RBI did not wait for too long. After all, the biggest risk for India was monetary divergence from the Fed and other global central banks. Like the US and China, the RBI also opted to front-end rate cuts to the extent that in just two rounds, in April and June 2020, the RBI dropped repo rates by 125 basis points. This was also supported by an unprecedented fiscal stimulus, at a level India found it tough to afford. But that was still the better option.
If front-ending rate cuts was one side of unconventional monetary policy, the other side was significant use of Long Term Repo Operations or LTROs in the money markets and bond markets. The RBI, for the first time, extensively used the Targeted LTROs or TLTROs (also called Operation Twist) to tweak the smoothness of the yield curve. This significantly lowered fund costs.
A bold and countercyclical budget
In a way, the Union Budget 2021 marked the culmination of an extremely unusual and anomalous year. The government had to drive a fiscal package of $350 billion to keep the factories chugging. While, it did prevent an outright recession, it came at the cost of a much steeper fiscal deficit as was evident in the Union Budget 2021.
Let us look at the Budget Deficit or Fiscal Deficit first. The original estimate of Gross Fiscal Deficit for FY21 of 3.5% was substantially yanked up to 9.5% for FY21. That is a divergence of nearly 600 basis points. Similarly, the fiscal deficit estimate for FY22 was also substantially higher at 6.8%. And remember, these are not final estimates and could still change. After all, even as direct and indirect taxes are getting back to pre-COVID levels, the demands of an economy on the throes of a recovery are quite huge. As a result, the government has pushed back the 3.5% fiscal deficit target by 5 years till 2026.
For FY22, the gross market borrowings via dated securities stands pegged at Rs12.10 trillion, compared to Rs12.80 trillion in FY21. What is perhaps worrying is that nearly a quarter of the gross fiscal deficit has been funded by the National Small Savings Fund (NSSF), which is public money held in trust by the government. The debt/GDP ratio worsened to 64.3% in FY21, though it may be slightly better at 62.5% in FY22.
How were household savings and household debt impacted in FY21?
Household savings saw a rapid fall in FY21. For example, the household financial savings rate was 21% in Q1-FY21 but fell to 10.4% in Q2-FY21, which saw most households relying heavily on their accumulated savings and PF balances to make ends meet. Also, there was a sharp spike in spending due to huge pent-up demand. The data for Q3 and Q4 household savings are not available but RBI estimates it would have dropped further on a spike in consumption.
The other area of worry is the consistent rise in household debt to GDP ratio, which has been on a rise since April 2018. In fact, between Q1-FY21 and Q2-FY22, the household debt to GDP ratio increased from 35.4% to 37.1%.
What the RBI has encapsulated is that FY21 has created substantial risks for the health of the economy and also for financial health of Indian households. The biggest palliative will be solid growth recovery in FY22!