RBI may keep rates unchanged, but 25 bp cut desirable

Many central banks like the US Federal Reserve took an innovative stand. The Reserve Bank of India will need to do the same.

By Arvind Virmani

While comparing the first quarter GDP data for 2020-21 with 2019-20, it is clear that the biggest hit from the pandemic and the lockdown was taken by the construction sector with a ratio of 0.5 and “trade, hotels, restaurant, and communication & broadcasting with a ratio of 0.53. Manufacturing fared a little better at 0.61, compared with the total GDP ratio of 0.77.

Surprisingly, mining was unchanged at 0.77, perhaps because many mines are located in rural and remote areas, untouched by the lockdown. If we look at the IIP for mining, electricity and manufacturing, the ratio of Q1 this year to last year is almost similar to previous year’s data. June IIP ratios show that capital goods and consumer durables remain the worst affected sectors, along with textiles and apparel, motor vehicles and other transport equipment.

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The unemployment index (based on CMIE data) for February this year was 1.1 and rose to 1.3 in March. It spiked to 3.3 in April and 3.3 in May as lockdown took effect. However, with the lifting of the lockdown, it declined to 2.4 in June. Surprisingly it had become completely normal at a value of one in July and August.

There is a caveat, however, because the labour force participation rate (LFPR) in June, July and August was 2 percentage point higher than the average rate last year. This was primarily due to regular wage employees, who had both the knowledge and the economic capacity to withdraw from the labour force while the pandemic raged.

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Given this background, it is rather surprising that most members of the MPC not only stuck to a literal, narrow interpretation of their mandate, but also chose to focus on short run inflation instead of taking a forward-looking approach. Given the once in a century shock, comparable to the Great depression, many central banks, like the US Federal Reserve, have innovated. There is a need for the MPC to do the same.

Recommendation — Cut by 25basis points
Forecast — Pause

(Dr Arvind Virmani is Chairman of EGROW Foundation, a Noida-based think tank. This article is the reproduction of his views presented at the shadow monetary policy committee meeting organised by EGROW Foundation.)

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