Policy Settings For 2022: A Delicate Choice

India’s growth recorded a stellar 20.1 per cent for Q1FY22 and 8.4 per cent in Q2FY22. Most forecasters have pencilled in a 9.5 per cent or thereabouts real growth for the year, after a contraction of 7.3 per cent in the previous year. 2021 has thus been a period of rebuilding for the economy. India is like a child, badly injured in an accident and is just starting to get back on its feet, though it would still need support. The year 2022 is likely to continue to pose challenges and policy support will be crucial to ensure a safe soft landing for the economy.   

After the COVID-19, monetary policy was the first to support by easing policy rates and simultaneously ensuring adequate system liquidity. Even as the RBI lowered the policy rate to 4 per cent, it moved the reverse repo rate lower (widened the LAF corridor) to try and nudge banks to lend rather than passively return the surplus liquidity to the RBI. Further, it expanded its balance sheet to ensure the government’s large borrowing programme is completed smoothly. RBI also expanded its role to direct credit flows to the neediest sectors, targeted lending facilities such as the TLTROs are examples.  

Monetary policy is at a crossroads now, inflation has surprised the world, not only being high but also proving to be sticky. For India, high and sticky inflation is associated with a large negative output gap, making the situation difficult for RBI. The RBI has tilted towards supporting growth and hence stayed put with a repo rate of 4 per cent and its accommodative stance. However, the situation could turn tricky if the globe (especially the US Fed) launches an aggressive withdrawal of monetary accommodation, or if India’s inflation shows signs of getting entrenched.  

The RBI has started to move away from the Coronavirus-led excessive easy monetary policy. It has soaked up the overnight liquidity. Its VRRR rate is now close to the repo rate (signalling rate). All other interest rates have started to exhibit an upward momentum and we may just be a few months away from the time RBI would have to raise the repo rate. This means that the support of low-interest rates for the economy would be over soon.  

With monetary policy tightening, the mantle for supporting growth falls on the lap of fiscal policy. This is contrary to some expectations in the market that the fiscal consolidation would start in FY23 with the Budget on February 1, 2022, adhering to a path of correction in the Gross Fiscal Deficit/GDP ratio. The criticality of fiscal policy is also borne out by the fact that various segments of the economy continue to face different kinds of stress. Interest rate tools may not be best suited in this situation.  

On the production side, the organised, listed companies have weathered the storm better - managing to deleverage, gain market share vis-à-vis the smaller entities and are thus in a better position to even pass on the higher input costs to the consumers. Government policies had been put in place to enable faster growth in private investments especially with the PLI scheme, reduction in corporate tax rates etc. But the reality is that private sector companies have not been forthcoming with capacity-building investments, even though their balance sheets are lean and trim and are well equipped for the same. The reason: capacity utilisation levels are low and hopes for a surge in private consumption demand is lacking.   

It is probably time for consumers to receive some help from the fiscal side, also as the lure of extremely low-interest rates are likely to go. Through the COVID-19 stress, fiscal policy has shied away from any direct cash transfer fearing that these could be wastefully spent. But Private Final Consumption Expenditure (PFCE) remains the most crucial contributor to the economy with its 50 per cent plus share in the GDP. PFCE is yet to recover to the pre-COVID-19 levels, even as it recorded a 9 per cent Q-o-Q growth in Q2FY22. Valuables on the expenditure side of GDP has jumped by 603 per cent on Q-o-Q basis in Q2FY22 and is also up by 183 per cent compared to Q2 of last year. This represents purchases of expensive durable goods that do not depreciate over time but are not used in consumption or even production. Probably, the excess savings that were piled up by the upper strata of the society during COVID-19 is now being spent for these purposes and this boost to the GDP might not be sustainable.   

Rural wage growth is low and negative on a real basis. The gap between employment provided and work demanded under the rural employment guarantee scheme is large, meaning labour is yet to come back for their urban jobs and rural jobs beyond the MNREGA are difficult to find. 

All this forms the basis for arguing that fiscal policy needs to take up the mantle to provide stability to growth, not only for the near future but also keeping the long-term imperatives in mind. The government needs to continue to maintain its redistributive policies and boost employment generation. Inequality exists in the access of education and healthcare, areas that the fiscal should start addressing. Efforts at reskilling need to be boosted urgently for labour to be absorbed in the newer growth areas. This is unlikely to be achieved in just a year, but somewhere a start must be made. For resources, the government needs to take its asset monetisation plans and divestment efforts seriously, tighten tax compliance alongside some redistributive tax policies.