The central banks in most economies have twin objectives of maximizing employment/growth and keeping prices stable at around targeted levels. However, covid19 put forward an unprecedented syndrome to grapple with and most central banks, have tried to inject liquidity into their respective economies through lowering interest rates, buying bonds and easing out credit deployment and repayment terms as they struggled to deal with sudden slow down in the economic activity due to the pandemic . Clearly, the Central Banks have tough choices to make as they need to maintain financial stability upbeat on one hand and the employment-inflation trade-off on the other hand.
For instance, in the US, Fed was able to keep the gears of the economy running as scientists developed vaccines and Americans figured out how to live in a Covid19 infected world. However, as inflation was observed to be somewhat higher than the Fed’s target rate of around 2 percent while the jobs market still needed time to recover, the dilemma was that if the Fed were to raise rates in order to scale down inflation, it would also slow economic growth and thus hurt the pace of recovery in the labor market. But even as it chose to keep the rates steady, there seemed to be a possibility that it could even exacerbate inflation. The Fed Open Market Committee has decided to continue to give utmost concern to jobs market and kept short-term borrowing costs at near-zero levels and continue buying $120 billion a month in long-term bonds.
Balancing the twin goals of maintaining price stability on one hand and ensuring the growth of the economy on the other, in itself is a challenging task, yet, additionally the central banks may also have to be equally concerned about the sentiments of the people in order to keep the circular flow of income in the economy at its optimum level given the constraints posed by the pandemic related lockdowns.
In this context, the recent instance of reversal of the view taken by the US Federal Reserve in a span of less than a month is worth discussing. In the third week of June 2021, Fed gave a hint that there may be a possibility of two rate hikes by the year 2023 but this caused turmoil in the stock market. However, in the second week of July, in congressional testimony the Fed chair Powell said that high inflation for goods and services tied to the reopening and the US economy was “still a ways off” from levels the Fed wanted to see before tapering its stimulus support. This was seen as an attempt to soothe the investor sentiment as was also reflected by a rebound in the US stocks.
Economic stimulus has led to growth but it is uneven across countries
The Reserve Bank of India, in its recently released Financial Stability Report, has identified rising crude oil prices, emerging inflationary pressures and global policy uncertainty as the key risks faced by the global economy even as it recovers from the ravages of the COVID-19 pandemic. Thus, even as economic activity has been gaining momentum, it is seen as unevenly at the global level.
Fitch Ratings expects 2021 world GDP to grow by 6.3%, which has been revised upwards by 0.2pp since March’s Global Economic Outlook (GEO). Incoming data, earlier-than-expected service sector re-opening in the US and Europe, and the impact of policy support lie behind the upgrade. Fitch has raised its 2021 growth forecasts for most developed economies, with the US revised to 6.8% from 6.2%, the eurozone to 5.0% from 4.7%, and the UK to 6.6% from 5.0%. Only Japan has seen a reduction to 2.5% from 3.6%. China’s forecast remains at 8.4%, however, they have cut emerging markets (EM) excluding China growth to 5.9% from 6.0%. Downward revisions to India, Indonesia and Turkey are partly offset by upward revisions to Brazil, Mexico and South Africa.
Reserve Bank is faced with dilemmas too
According to the RBI, with the vaccination drives gathering momentum and policy support maintained, the global economy is gradually recovering from the ravages of the COVID-19 pandemic, though divergently and unevenly across countries. The plus point is that the capital flows have made a cautious return to emerging market economies (EMEs). However, there have been concerns about increase in inflation and loss of welfare in less developed economies in the wake of a broad-based upswing in commodity prices.
Further, due to large scale economic support required for safeguarding the interests of the covid19 infected/affected economies there has been an unprecedented rise in government debt globally amidst a decline in government revenues and increased spending to safeguard economic and social welfare in the wake of mass lockdowns /slowdown of economic activities in most economies of the world.
The good thing is that the banks have remained relatively unharmed by pandemic-induced disruptions, thanks to the timely support given by regulatory, monetary and fiscal policies, yet, they do face the possibility of an increase in non-performing loans, particularly in their small and medium enterprises (SME) and retail portfolios, as and when the regulatory support by respective governments is withdrawn.
In India, the second wave has disrupted the pace of economic activity, even as the markets and financial institutions have so far shown signs of resilience. The fiscal equations of the Central and State governments have been strained by increased expenditure on health care and welfare measures. To add to the woes, the increase in the international prices of crude oil and other key commodities poses considerable risk of fueling inflation expectations and adversely impacting the trade balance.
The credit flow from banks and capital expenditure of corporates have shown little signs of improvement. While the banks’ exposures to better rated large borrowers are reported to be declining, there are signs of increased stress seen in the micro, small and medium enterprises (MSMEs) and retail segments. Further, the demand for consumer credit across banks and non-banking financial companies (NBFCs) has been adversely affected.
The Monetary Policy Committee (MPC) thus, at its meeting held on June 4, 2021 has kept the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 4.0 per cent in the light of the current and evolving macroeconomic situation. Much on the same lines, the reverse repo rate under the LAF remained at the previous level of 3.35 per cent and the marginal standing facility (MSF) rate and the Bank Rate at 4.25 per cent.
Clearly, the MPC decided to continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.