The second-round effects would operate through a severe slowdown in global trade and growth. “More immediately, spillovers are being transmitted through finance
and confidence channels to domestic financial markets.”
These would inevitably accentuate the growth slowdown, which started in the first quarter of the 2018-19 financial year and continued through the second half of 2019-20.
The outlook for 2020-21 growth was looking up before the Covid-19 scare. There was a bumper rabi harvest, and higher food prices during 2019-20 provided conducive conditions for the strengthening of rural demand. The transmission of policy rate cuts was also improving, with favourable implications for both consumption and investment demand. Reductions in the goods and services tax (GST) rates, corporation tax rate cuts in September 2019, and measures to boost rural and infrastructure spending were to have a positive impact at boosting domestic demand. But “the Covid-19 pandemic has drastically altered this outlook”, the monetary policy report said.
The central bank now expects the global economy “to slump into recession in 2020, as post-Covid-19 projections indicate”. However, the sharp reduction in international crude oil prices, if sustained, could improve the country’s terms of trade. “But the gain from this channel is not expected to offset the drag from the shutdown and loss of external demand,” the RBI said.
Professional forecasters polled in March, before the announcement of the nationwide lockdown, had expected real GDP (gross domestic product) growth might recover from 4.6 per cent in the fourth quarter of 2019-20 to 6.1 per cent in the fourth quarter of 2020-21.
The RBI advanced its monetary policy committee
(MPC) meeting in March from the first week of April in view of the Covid-19 lockdown. In its off-cycle meeting, the MPC noted that the macroeconomic risks brought on by the pandemic could be severe, both on the demand and supply sides, and stressed upon the need to do “whatever is necessary to shield the domestic economy from the pandemic.”
A policy repo rate cut of 75 basis points was accompanied by several liquidity-enhancing measures to improve monetary transmission and credit flows to the economy, and to provide relief on debt servicing. However, “the accompanying lockdowns and the expected contraction in global output in 2020 weigh heavy on the growth outlook”, the report said.
The RBI said that the full impact would depend upon the speed with which the outbreak was contained and economic activity returned to normalcy. The measures taken by the RBI and the government are expected to mitigate the adverse impact on domestic demand and help spur economic activity when normalcy is restored. The inflation, though, is expected to remain benign “relative to recent history”.
Even as forecasts are hazardous in this environment, the RBI is mandated to provide inflation
forecasts. Therefore, taking into account initial conditions, signals from forward-looking surveys and estimates from time series and structural models, the central bank projected retail inflation
to tentatively ease from 4.8 per cent in the first quarter to 4.4 per cent in the second quarter. It said it expected inflation
to be at 2.7 per cent in the third quarter and 2.4 per cent in the fourth quarter, “with the caveat that in the prevailing high uncertainty, aggregate demand may weaken further than currently anticipated and ease core inflation further, while supply bottlenecks could exacerbate pressures more than expected”.
For its projections, the RBI’s baseline scenario assumed crude oil prices (Indian basket) to average around $35 per barrel during 2020-21, fiscal deficit as a percentage of gross domestic product (GDP)
for the Centre at 3.5 per cent, and the combined GDP deficit at 6.1 per cent. Besides, an exchange rate of Rs 75 per dollar, a normal monsoon, but a global growth contraction in 2020, were assumed. It was also assumed that there would be no major change in domestic structural policy.