Budget is the key instrument to push growth: EY report

The EY report said retail inflation in India is expected to remain high in the current calendar year compared to other major economies

The policy thrust to support growth may have to come almost entirely from fiscal policy initiatives and the Budget is expected to be a key instrument for that as the central bank is unlikely to reduce policy rates further in the near future to boost the economy amidst prevailing high inflation rate, the latest edition of EY Economy Watch has said.

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“With CPI [consumer price index] inflation remaining well above the upper threshold of the monetary policy target of 6%, the monetary authorities may not be inclined to reduce further the policy rate from the current level of 4%. As such, in the near future, the policy thrust to support growth may have to come almost entirely from fiscal policy initiatives of which the FY22 union budget may be a key instrument,” DK Srivastava, chief policy advisor at consultancy firm EY India, said in the edition.

India’s gross domestic product (GDP) contracted sharply to 23.9% in the first quarter of the current financial year mainly because of the Covid-19 pandemic, which led to a 68-day nationwide hard lockdown. Some economic recovery did take place in the second quarter that helped in moderating the contraction. GDP grew at -7.5% in Q2 of 2020-21.

Although the CPI inflation declined from a 77-month high of 7.6% in October to 6.9% in November this year mainly due to softening of vegetable rates, it is quite high from the Reserve Bank of India (RBI)’s set a target of 4% with the upper tolerance limit of 6% and the lower tolerance limit of 2%. The primary objective of RBI’s monetary policy is to maintain price stability while keeping in mind the objective of growth. According to the central bank, price stability is, however, a necessary precondition to sustainable growth.

The RBI’s Monetary Policy Committee (MPC) has decided to keep both the repo rate and the reverse repo rate unchanged at 4% and 3.35%. “These decisions are in consonance with the objective of achieving the medium-term target for consumer price index [CPI] inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth,” the minutes of MPC meeting held from December 2 to 4 said. According to RBI, the outlook for inflation has turned adverse relative to expectations in the last two months. It has projected CPI inflation at 6.8% for the third quarter ending December 31.

The EY report said retail inflation in India is expected to remain high in the current calendar year compared to other major economies. “The monetary authorities, in the initial period of the crisis [Covid-19 pandemic], appeared to be more proactive in providing stimulus. They reduced the repo rate from 5.15% in February 2020 in two steps to 4.0% in May 2020. A variety of other liquidity enhancing measures were also undertaken. However, as CPI inflation started firming up, the monetary authorities became less active in further strengthening monetary stimulus,” it said.

Under the circumstances, the report expects the Budget to announce significant fiscal measures to boost growth as the central bank may not be in a position to reduce policy rates further. “The RBI expects core inflation also to remain sticky. Given this sustained breach of the policy target, RBI is likely to maintain the status quo and the repo rate at 4% for the remaining part of the fiscal year although this situation may be reassessed in the next MPC meeting scheduled in February after the presentation of FY22 Union Budget,” the edition said. The government is expected to present the Budget 2021-22 on February 1.