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Rural economy expected to bounce back after kharif season: RBI

Published: Aug 07, 2020

By TIOLCORPLAWS News Service

MUMBAI, AUG 07, 2020: The Monetary Policy Committee met on 4th, 5th and 6th August for its second meeting of 2020-21, the 24th under its aegis, completing four years of its operation under the new monetary policy framework. In the MPC's assessment, global economic activity has remained fragile and in retrenchment in the first half of 2020. A renewed surge in COVID-19 infections in major economies in July has subdued some early signs of revival that had appeared in May and June. Global financial markets, however, have been buoyant, with the return of risk-on sentiment inserting a disconnect from the underlying state of the real economy. Portfolio flows to emerging markets have resumed and their currencies have appreciated.

The MPC noted that in India too, economic activity had started to recover from the lows of April-May; however, surges of fresh infections have forced re-clamping of lockdowns in several cities and states. Consequently, several high frequency indicators have levelled off. The agriculture sector's prospects are strengthened by the progress of the south-west monsoon and expansion in the total area sown under kharif crops by 13.9 per cent up to July 31 over last year. Industrial production remained in contraction albeit at a moderated pace in May. The manufacturing purchasing managers' index (PMI) shrank in July for the fourth consecutive month. The PMI services remained in contractionary zone in July, although the downturn eased, relative to the June reading.

Against this backdrop, the MPC was of the view that supply chain disruptions on account of COVID-19 persist, with implications for both food and non-food prices. A more favourable food inflation outlook may emerge as the bumper rabi harvest eases prices of cereals, especially if open market sales and public distribution offtake are expanded on the back of significantly higher procurement. Nonetheless, upside risks to food prices remain. The abatement of price pressure in key vegetables is delayed and remains contingent upon normalisation of supplies. Protein-based food items could also emerge as a pressure point. Higher domestic taxes on petroleum products have resulted in elevated domestic pump prices and will impart broad-based cost push pressures going forward. Taking into consideration all these factors, the MPC expects headline inflation to remain elevated in Q2:2020-21, but likely to ease in H2:2020-21, aided by favourable base effects.

As regards the outlook for growth, the MPC noted that the recovery of the rural economy is expected to be robust, buoyed by the progress in kharif sowing. Manufacturing firms expect domestic demand to recover gradually from Q2 and to sustain through Q1:2021-22. On the other hand, consumer confidence turned more pessimistic in July relative to the preceding round of the Reserve Bank's survey. External demand is expected to remain anaemic under the weight of the global recession and contraction in global trade. Taking into consideration the above factors, real GDP growth in the first half of the year is estimated to remain in the contraction zone. For the year 2020-21 as a whole, real GDP growth is also estimated to be negative. An early containment of the COVID-19 pandemic may impart an upside to the outlook. A more protracted spread of the pandemic, deviations from the forecast of a normal monsoon and global financial market volatility are the key downside risks.

The MPC noted that in an environment of unprecedented stress, supporting recovery of the economy assumes primacy in the conduct of monetary policy. While space for further monetary policy action is available, it is important to use it judiciously to maximise the beneficial effects for underlying economic activity. At the same time, the MPC is conscious of its medium term inflation target. The headline inflation prints of April-May 2020 are obscured by (a) the spike in food prices and (b) cost-push pressures. Meanwhile, the cumulative reduction of 250 basis points is working its way through the economy, lowering interest rates in money, bond and credit markets, and narrowing down spreads. Given the uncertainty surrounding the inflation outlook and extremely weak state of the economy in the midst of an unprecedented shock from the ongoing pandemic, the MPC decided to keep the policy rate on hold, while remaining watchful for a durable reduction in inflation to use available space to support the revival of the economy.

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