With the emergence of the second wave of Covid-19 pandemic, we have come back to square one. The growth estimates coming down on one hand and the inflation rates going higher on the other seems to be vanishing the balance between the growth-inflation trade-off. While the monetary policy of India has its mind on keeping the economic growth steady with stable prices, how RBI’s accommodative approach is helping maintain this balance amid the surge in the covid-19 cases again along with the factors leading to a rise in inflation rates in the Covid-19 era is what this paper focuses on.
The outbreak of the second wave of Covid-19 in India is no less than a déjà vu. The country has plunged itself to where it was a year ago with, of course, the obvious dents. The days of the great lockdown, businesses on halt and a chaotic health emergency are back. It is like Indians have taken the pandemic mantra of “We are all in this together” far more seriously. While half the population is struggling inside the hospitals holding to the oxygen cylinders to stay alive, the rest are struggling inside their homes to get at least the bare minimum means to survive. In other words, people are dying all over the nation – be it due to covid-19 or its outlasting effects on the economy. The pandemic whodunit had many surprises lined up for us. The Health Experts continue to research the horrifying long-lasting effects of the new virus variant, the Economists, on the other hand, went brouhaha on the shocks the Indian economy is bearing all over again. Needless to say, “The virus may in-fact be as contagious economically as it is medically”[i].
Although, the pandemic is hitting the Indian economy real hard, what’s more, upsetting is the rise of inflation in the country. The news flash of “Petrol touching Rs.100 mark for the third time in the row” or “WPI hits 11 year high of 10.49%” is getting scarier day by day. The Reserve Bank of India, looking at the U-turn the Indian economy took from its recovery tracks of the 2020 nationwide economic halt, has warned that “The resurgence in Covid-19, if not contained in time, risks protracted restrictions and disruptions in supply chains with consequent inflationary pressures”[ii]. Sustaining high economic growth with low levels of inflation is one of the top priorities of any economy’s macroeconomic policy, however, at present the Indian economy seems to be moving backward from this fundamental goal. Nevertheless, the question here persists that how the pandemic has contributed to the prevalence of high inflation in the economy and how RBI, or to say our monetary policy framework has reacted to the increasing inflation rates?
THE HOLY GRAIL OF INFLATION IN THE COVID-19 ERA
We are standing at a difficult crossroad says Professor Jayanth Varma, a member of the monetary policy committee (MPC), where the rates of inflation have been consistently well above the mid-level of the target set and are forecast to remain elevated for some time[iii]. The trajectory of inflation has been hit “again” by the shadow of Covid-19. The CPI inflation stood at 5.52% in March 2021, exceeding the rate of 5.03% in February and 4.06 % in January 2021. The WPI inflation, consisting of fuel and manufacturing products, stood at 10.49% in April 2021 – the highest record of the past decade[iv]. What possible factors would have led us to this crossroad is the question of the hour here?
One of the obvious factors leading to inflation is the “Supply-Demand Mismatch”. Initially, when the news of the nation lockdown made the headlines back in March 2020, the supply disruptions with the “consumer panic buying” of groceries and medical supplies led to an increase in the prices of consumer goods. However, the second wave had come with some ready preparations. Along with the disruptions in supply due to the state lockdowns and restrictions, the population intended to save more than consume leading to the reduction in demand and henceforth, the food prices.
The RBI deputy governor Michael Patra noted that “the inflation print of February reflects pandemic effects in the form of input cost pressures- though still muted in translating into selling prices- retail margins and increased costs of doing business as supply chains are still mending”[v]. Dr. Mridul Saggar feared that in the future a possible factor that could level up the CPI inflation would be if the producers start sliding the burden of production cost at the retail level[vi]. Scholars like Ila Patnaik and Radhika Pandey are of the view that the CPI inflation was driven by an increase in limited components of the food basket and majorly by an increase in fuel and transportation costs[vii]. In addition to this, one of the factors observed was the “High global inflation” that’s been entering into the nation through imported manufactured goods[viii].
Economists like Sreejith Balasubramanian, hold the view that “apart from fuel prices and cost-push pressures, the crisis in the informal sector has probably a reason for high headline inflation. Rather than supply bottlenecks, it is possible that the production itself has come down, especially those items manufactured and serviced by small informal enterprises. Typically, these are the low value-adding items consumed daily by the majority of the populace”[ix].
An IMF’s special note series on Covid-19 reports one of the factors responsible for rising inflationary pressures in the nation and that is the “Monetary policy framework. In an environment with well-anchored inflation expectations as a result of credible monetary policy, the more aggressively monetary policy reacts to higher inflation, the lower inflation expectations and the materialized inflation will be. At the same time, monetary policy rules that put a high weight on output stabilization might produce excessive inflation in the face of a negative supply shock. This can worsen the trade-off between lowering inflation and stabilizing output when inflationary pressures are due to supply disruptions during the recovery phase”[x]. Having said that, we proceed to how RBI has reacted to the inflation surge amid the second wave.
THE TUNING OF RBI TO TACKLE COVID-19 INFLATION.
Many scholars have inferred that during a crisis, the relationship between the monetary policy and inflation doesn’t seem so reliable, lining up classic problems for the central bank. The outbreak of the second wave was indeed a challenging time for RBI when reducing the interest rates was seen as the viable option however, the RBI’s stance to leave the interest rates untouched and following the accommodative approach until the recovery of economic growth can be seen from naked eyes, has become the talk of the town. By accommodative approach, it means that the RBI has the right to cut the interest rate any time it seems fit to inject more liquid into the system and growth. “So far the RBI has been quite accommodative-reduced policy rates by 115 basis points (bps), and since February 2019 by good 250 bps to support growth”[xi]. However, in any circumstances the inflation rate exceeds RBI’s tolerance range, then there would be no other option but to increase the interest rates.
In addition to the accommodative approach, the monetary policy committee has also laid down a few norms for the small businesses, MSMEs, stakeholders where they have eased the lending and restructuring process. The schemes/norms like “on tap TLTRO for specific sectors and bank lending to NBFC’s for on-lending to agriculture, MSME, housing sectors as priority sector lending; the additional refinancing facility provided for SIDBI, NHB, and NABARD; and the relaxation in the period of parking of external commercial borrowing (ECB) proceeds in term deposits, all seems to be the positive steps taken by RBI as the response to the second wave surge in the nation”[xii].
This quick response and the gradual rollback has been the RBI’s strategy since the beginning to tackle policy matters amid the pandemic and to say that RBI will continue to see through elevated inflation and focus on supporting growth at least until the Covid-19 risk is firmly behind, would be a truism.
[i] Richard Baldwin and Beatrice Weder di Mauro (eds.), Economics in the times of Covid-19, (CEPR Press, 2020).
[ii] Reserve Bank of India Bulletin, April 26, 2021.
[iv] Pallavi Nahata, “India’s WPI Inflation jumps to 11 year high in April” The BloombergQuint, May 17, 2021.
[v] Sesa Sen, “Second Covid-19 wave biggest risk to economic recovery: RBI
Governor Shaktikanta Das” The new Indian express, April 23, 2021
[vii] Ila Patnaik and Radhika Pandey, “Why higher inflation could be India’s next big worry amid worsening covid-19 crisis” The print, April 26, 2021.
[ix] Abhishek Waghmare, “Under the Shadow of Covid-19 Pandemic, Inflation bites India the hardest” Business standard, December 16, 2020.
[x] International Monetary Fund (IMF), “The impact of Covid-19 on inflation: The potential drivers and dynamics” (September 10, 2020).
[xi] Rounaq Neroy, “How would RBI approach its April 2021 monetary policy amid the second wave of covid-19” Daily wealth letter, April 03, 2021.
[xii] Press trust of India, “RBI’s accommodative policy stance reassuring to industry, trade: chambers” April 07, 2021
13. MG. Arun, “Why rising inflation: Covid could be a spoil sport in growth recovery” India today April 08, 2021.
14. Anand Adhikari, “Big upset for RBI! Second covid-19 wave to disrupt GDP, infection projection” Business today April 06, 2021.