Aditi Nayar The October 2021 monetary policy review and the accompanying announcements from the Reserve Bank of India did not throw up any surprises.

As expected, the MPC (Monetary Policy Committee) unanimously maintained the repo rate at 4 per cent, kept the monetary policy stance accommodative with a vote of 5:1, and retained the FY22 GDP growth forecast at 9.5 per cent. It did reduce its FY22 CPI inflation projection to 5.3 per cent from 5.7 per cent with risks broadly balanced.

Moreover, the RBI prudently chose not to surprise the markets, and kept the reverse repo rate steady at 3.35 per cent. As anticipated, it announced a calendar for 14-day variable rate reverse repo (VRRR) auctions and indicated a pause in the government-securities acquisition programme (G-SAP).

The RBI’s survey revealed that capacity utilisation for the manufacturing sector had fallen from 69.4 per cent in Q4 FY21 to 60 per cent in Q1 FY22. Moreover, household confidence has improved modestly in the September 2021 survey round, whereas business confidence has revived much faster.

In ICRA’s assessment, the most crucial sentence in the monetary policy statement is: “The recovery is uneven and critically dependent upon policy support.”

There is mounting evidence that the performance of economic activity in FY22 is rather K-shaped, with the contact-intensive sectors still lagging, and MSMEs and less-formal enterprises ceding ground to the large, formal players. The latter trend had emerged after demonetisation and GST, and has intensified after the pandemic.

K-shaped recovery

The K-shaped recovery resonates in various available data, including the healthy performance of direct taxes in H1 FY22 and the soaring stock market, even as the the RBI’s survey suggests that the current situation index of the consumer confidence survey remains in the pessimistic zone despite a modest pickup.

There is unevenness in the performance of ICRA’s rated portfolio as well. In H1 FY22, ICRA upgraded the ratings of 303 entities, reflecting an improvement in the credit profile of 10 per cent of the portfolio. However, almost half of the upgrades were concentrated in eight sectors, namely ferrous metals, pharmaceuticals, healthcare, power, construction, engineering, auto ancillaries and real estate, which account for one-third of ICRA’s portfolio. At the same time, a lower 163 instances of downgrades were seen in H1 FY22, which includes contact-intensive sectors such as hospitality and aviation.

The underlying business fundamental metrics across most sectors, even those that have seen the most upgrades, are unlikely to exceed the pre-Covid levels in the near term.

This is broadly in line with ICRA’s view that the real GVA of some of the non-agricultural sub-sectors in FY22 will remain below the FY20 level. ICRA expects real GDP to grow 9 per cent in FY22, slightly lower than the MPC’s projection of 9.5 per cent.

Following the MPC’s stark comment that the recovery is critically dependent upon policy support, ICRA expects it to maintain status quo on the repo rate and an accommodative stance until demand-side pressures start dominating the inflation outlook. In the Q2 FY22 GDP data to be released by the NSO at the end of November, the festive season trends will provide valuable cues to gauge the durability of the consumption revival.

In line with the moderation in food inflation, households’ inflation perceptions have eased. The pain points for the inflation outlook currently include supply-side factors such as high commodity and edible oil prices, input shortages and logistics costs. However, as demand strengthens, producers’ pricing power would also make a comeback, allowing input costs to transmit to core inflationary pressures.

If the GDP growth for Q2 FY22 meets the MPC’s forecast, the RBI could bring in a 15 bps hike in the reverse repo rate in December 2021, to narrow the corridor with the repo rate.

Next, the MPC could change the stance of monetary policy to neutral from accommodative in its February 2022 review.

Subsequently, the repo rate could be hiked by 25 bps each in the April 2022 and June 2022 meetings, along with commensurate reverse repo hikes.

What can the fiscal policy do as monetary policy moves gradually towards an eventual normalisation? Encouragingly, the government eased its cash management guidelines at the end of September. This is expected to result in spending being ramped up in H2 this fiscal, which will unleash a virtuous cycle of economic activity as well as confidence.

The impact of this will be complemented by the release of GST compensation cess of ₹22,000 crore, as well as the second tranche of the back-to-back GST compensation loan of ₹40,000 crore, both of which will benefit States’ cash flow situation, allowing accelerated spending in Q3 FY22.

Additionally, ICRA expects gross tax collections to exceed the FY22 BE by around ₹2 trillion, of which roughly ₹600 billion will flow to the States, and could potentially boost their spending in Q4 FY22.

With crude oil prices climbing to $80/barrel, the MPC has called for calibrated cuts in indirect taxes on petrol and diesel by both the Central and the State governments, as a tool to achieve a more durable reduction in inflation and aid in the anchoring of inflation expectations. Such cuts will help to stave off repo hikes, and prevent consumers from being reticent during the festival season.

The writer is Chief Economist, ICRA