Mumbai: Cautioning that India's potential output may undergo a structural downshift following the pandemic, the Reserve Bank on Tuesday made a strong case for deep-seated and wide-ranging reforms to regain losses and return to the path of sustainable economic growth.
The COVID-19 pandemic will inflict deep disfiguration on the world economy and the shape of the future will be heavily contingent upon the evolving intensity, spread and duration of COVID-19 and the discovery of the elusive vaccine, the RBI said in its 'assessment and prospects' which forms part of the central bank's Annual Report for the year 2019-20.
Post-COVID-19, the overwhelming sense is that the world will not be the same again and a new normal could emerge, the Reserve Bank of India (RBI) said.
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"In a post-pandemic scenario, deep-seated and wide-ranging structural reforms in factor and product markets, the financial sector, legal architecture, and in international competitiveness would be needed to regain potential output losses and return the economy to a path of strong and sustainable growth with macroeconomic and financial stability," the RBI said.
As in the rest of the world, "India's potential output can undergo a structural downshift as the recovery driven by stimulus and regulatory easing gets unwound in a post-pandemic scenario," it noted.
Moreover, this recovery is likely to be different as the global financial crisis occurred after years of robust growth with macroeconomic stability; by contrast, COVID-19 has hit the economy after consecutive quarters of slowdown, it added.
Clear exit strategy, milestones needed for fiscal consolidation in coming years
The government should have a clear exit strategy and credible milestones for fiscal consolidation in the coming years, the Reserve Bank said in its annual report amid meeting the fiscal targets becoming more challenging due to the coronavirus pandemic.
Based on information from 25 states, the general government fiscal deficit increased from 5.4 per cent of GDP in 2018-19 to 6.5 per cent in 2019-20 (revised estimate). Further, outstanding liabilities rose to 70.4 per cent of GDP in 2019-20 (revised estimate) from 67.5 per cent in 2018-19, according to the annual report.
In 2020-21, fiscal deficit and outstanding liabilities are budgeted at 5.8 per cent and 70.5 per cent of GDP, respectively.
However, based on provisional accounts information, the general government fiscal deficit, including all states, is expected to deteriorate further to about 7.5 per cent in 2019-20.
"Thus, the fiscal gains achieved in the previous two years were reversed in 2019-20," the report said.
It noted that meeting the fiscal targets budgeted in 2020-21 has become even more challenging due to COVID-19, in view of containment measures and fiscal interventions for providing health infrastructure, helping vulnerable sections of the society and sector specific relief measures."
"In this scenario, it is desirable to have a clear exit strategy with credible consolidation milestones and timelines in reworking the path towards fiscal rectitude in the coming years," the report said.
Observing that most of the estimates for 2020-21 were worked out before the nation-wide lockdown, the report said, "given the shortfall in revenues – a direct fallout of subdued economic activity and increased expenditure requirement to fight the pandemic – the general government fiscal deficit and debt are likely to be materially higher than budgeted".
Govt consumption will have to fuel demand in times of COVID-19
Government consumption will have to fuel demand till the economy comes out of the COVID-19 shock and regains pre-COVID-19 momentum, the Reserve Bank's annual report said.
Private consumption, which has lost its discretionary elements across the board, particularly transport services, hospitality, recreation and cultural activities, will come in later as "behavioural restraints may prevent the normalisation of demand for these activities", RBI said in the annual report.
Going forward, it said, "government consumption is expected to continue pandemic-proofing of demand, and private consumption is expected to lead the recovery when it takes hold, with non-discretionary spending leading the way until a durable increase in disposable incomes enables discretionary spending to catch up."
An assessment of aggregate demand during the year so far suggests that the shock to consumption is severe, and it will take quite some time to mend and regain the pre-COVID-19 momentum, it said.
Banking system has to be liberated from risk aversion
As the pandemic has brought about dire need for liquidity, the Reserve Bank of India has said that the banking sector needs to get out of the risk aversion mode and give credit to the productive sector of the economy.
In its Annual Report for 2019-20, the RBI said that risk aversion of banks from giving credit is hampering credit flow to productive sectors.
"Turning to the financial sector, Indian banking has to be liberated from the risk aversion that is impeding the flow of credit to the productive sectors of the economy and undermining the role of banks as the principal financial intermediaries in the economy," it said.
The report noted that the deterioration in the macroeconomic and financial environment is impinging on asset quality, capital adequacy and profitability of banks.
RBI expects inflation to firm up further in coming months
Country's headline inflation is expected to firm up further in the coming months largely due to disruptions in food and manufactured items' supply chains, the Reserve Bank of India said in its annual report for 2019-20.
The Reserve Bank of India (RBI) said headline inflation picked up strongly during the closing months of 2019-20 and the short-term outlook for food inflation has turned uncertain.
"Disruptions in food and manufactured items' supply chains could amplify sectoral price pressures, thus posing an upside risk to headline inflation. Heightened volatility in financial markets could also have a bearing on inflation," said the RBI Annual Report 2019-2020.
All of these may influence inflation expectations of households, which are adaptive in nature, and show significant sensitivity to shocks to food and fuel prices, the report said.
Independent regulator needed for targeted public investment
The Reserve Bank of India has called for setting up an independent regulator for targeted public investment to revive and crowd in private investment.
In its Annual Report 2019-20, it said that targeted public investment funded by monetisation of assets in steel, coal, power, land, railways and privatisation of major ports by Central and state governments under an independent regulator can be the way forward to revive and crowd in private investment.
"In fact, goods and services tax (GST) Council type of apex authorities can be set up in respect of land, labour and power to drive structural reforms," the report said.
"They could include speedier implementation of the national infrastructure pipeline, a north-south and east-west road corridor together with a high-speed rail project that build on the successes of the golden quadrilateral, alongside steps to improve business sentiment and the environment for investment."
According to the RBI, states can be encouraged to publicise the availability of litigation-free land in their jurisdictions with access to modern infrastructure.
"In the power sector, the opportunity has arrived to leapfrog India into becoming the world leader in renewable energy by incentivising the domestic production of solar panels and connecting dispersed transmission links with remote areas. For the sector as a whole, elimination of cross-subsidisation through the tariff structure and provision of subsidy, if any, through direct benefit transfer (DBT) should be a priority, along with due consideration to the privatisation of electricity distribution companies (discoms)," the report said.
"With regard to railways, there is a strong case for manufacturing units to be corporatised. The growth potential of land banks can be exploited, particularly in metropolitan areas, by long-term leasing to the private sector, including for development of commercial real estate. FDI into railways can be encouraged by removing bottlenecks in the access to infrastructure - land; procurement rules; project risk-sharing mechanisms."
As per the report, a comprehensive policy is needed with regard to building adequate reserves of strategic materials, including the initiatives undertaken for crude oil.
It cited the need for diversifying financing options.
Rs 2,000 notes were not printed in 2019-20
Currency notes of Rs 2,000 denomination were not printed in 2019-20 and the circulation of these notes have declined over the years, according to RBI's annual report.
The number of Rs 2,000 currency notes in circulation has come down from 33,632 lakh pieces at end-March 2018 to 32,910 lakh pieces at end-March 2019 and further to 27,398 lakh pieces at end-March 2020, the RBI Annual Report said.
The number of pieces of Rs 2,000 denomination notes constituted 2.4 per cent of the total volume of notes at end-March 2020, down from 3 per cent at end-March 2019 and 3.3 per cent at end-March 2018.
In value terms also, the share has came down to 22.6 per cent at end-March 2020, from 31.2 per at end-March 2019 and 37.3 per cent at the end-March 2018.
On the other hand, the circulation of currency notes of denomination of Rs 500 and Rs 200 has gone up substantially, both in terms of volume and value over the three years beginning 2018.
Interest rates transmission improved during 2019-20
Adjustments in banks' deposit and lending rates in response to changes in the repo rate improved during 2019-20, especially in the second half of the year, the RBI said.
This was catalysed by the mandated linking of the interest rates on new loans to certain sectors such as personal and micro, small and medium enterprises (MSME), effective October 2019, to an external benchmark, the Reserve Bank said in its annual report.
The external benchmark can be the policy repo rate, three-month, six-month T-bill rates or any other benchmark published by the Financial Benchmarks India (FBIL).
During October 2019-June 2020, the weighted average lending rate of domestic (public and private sector) banks declined in respect of fresh rupee loans sanctioned for housing loans by 104 basis points (bps), vehicle loans by 102 bps, other personal loans by 115 bps and MSME loans by 198 bps, the report said.
Following the introduction of the external benchmark-based system of pricing of loans, 36 out of 66 banks adopted the policy repo rate as the external benchmark for floating rate loans to the retail and MSME sectors. Seven banks have adopted sector-specific benchmarks.
Difficult to accurately assess economic impact of COVID-19
The Reserve Bank said it is difficult to accurately assess the economic impact of COVID-19 pandemic as the dynamics are still evolving.
"COVID-19's epidemiological dynamics are still rapidly evolving in India, rendering difficult an accurate assessment of its full macroeconomic effects," RBI said in its annual report.
It said dynamic stochastic general equilibrium (DSGE) model built on New Keynesian foundations provides a tentative and proximate assessment of the likely impact of COVID-19 and the subsequent lockdown on the Indian economy.
The model is calibrated assuming that infections peak around the second half of August 2020 and the output gap widens to about (-) 12 per cent of potential output when the economy is worst hit, and considers three main economic agents, viz., households, firms and the government.
Because of lockdown, households have to stay at home and therefore, reduce labour supply to firms; consumption falls due to non-availability of non-essential items and fall in income; and restricted people-to-people contact stalls the momentum of the pandemic, it said.
RBI said the model envisages two scenarios -- the first, i.e., lockdown I, impacts the supply side of the economy by decreasing the labour supply and its productivity.
The second scenario, i.e., lockdown II, additionally considers the increase in marginal cost. While inflation is expected to decline under both the models, in the second scenario firms will curtail production as profits take a hit. Wages see a lower rise and economy goes through a large contraction.
"However, the recovery from the pandemic is faster in this scenario on account of fewer opportunities for people-to-people interactions.
"Under scenario I by contrast, production retrenchment is less severe, but demand contraction is more pronounced due to a rise in infections. Thus, the economy undergoes a deeper contraction under lockdown II, but recovery from the pandemic is faster," the RBI said.
In the third scenario, it said, the government does not impose a lockdown, the pandemic is more widespread and peaks in the second half of January 2021 with a very slow recovery.
"This causes a persistent labour shortage and the supply shock produces a lasting impact on inflation and the output gap, which corresponds to a permanent upward shift in inflation and a downward shift in potential output, respectively," the RBI said.
"In sum, COVID-19 without the associated lockdown acts like a supply shock which causes a persistent rise in inflation and a permanent loss of output," it said.
In the scenario of two lockdowns, which looks closer to reality, the decline in economic activity reaches its trough in April-June quarter of 2020-21 and recovers thereafter, albeit at a gradual pace, with growth turning positive from January-March quarter 2020-21, the RBI said.
Managing food surplus key challenge for India
India has now reached a stage in which surplus foodgrain management has become a major challenge, the Reserve Bank of India (RBI) said in its annual report.
The total production of foodgrains reached a record 296.65 million tonnes in 2019-20, while total horticulture production accounting for about 40 per cent of gross value added (GVA) in the farm sector also reached an all-time high of 320.48 million tonnes.
India is now among the leading producers of milk, cereals, pulses, vegetables, fruits, cotton, sugarcane, fish, poultry and livestock in the world.
As a result, the growth in agricultural GVA rose to four per cent in 2019-20. The farm sector contribution to overall economic growth surpassed that of the industrial sector for the first time since 2013-14, it added.
"India has now reached a stage in which surplus management has become a major challenge... Going forward, shifting the terms of trade in favour of agriculture is the key to sustaining this dynamic change and generating positive supply responses in agricultural production," the RBI said.
Turning to production activity, Indian agriculture is undergoing a distinct transformation notwithstanding headwinds, it said.
Therefore, the priority is to move towards policy strategies that ensure a sustained increase in farmers' income alongside reasonable food prices for consumers. An efficient domestic supply chain becomes critical here, it suggested.
Economic contraction likely to continue in Q2
The Reserve Bank of India said the contraction in economic activity was likely to continue in the second quarter of the current fiscal as upticks witnessed in May and June appears to have lost strength ifollowing re-imposition of lockdowns to contain the coronavirus pandemic.
The government imposed a nation-wide lockdown on March 25 to combat the pandemic. The lockdown was partially lifted and then re-imposed by certain states to check the spread of coronavirus infections.
According to RBI's annual report, high frequency data so far point to a retrenchment in activity that is unprecedented in history.
"the upticks that became visible in May and June after the lockdown was eased in several parts of the country, appear to have lost strength in July and August, mainly due to reimposition or stricter imposition of lockdowns, suggesting that contraction in economic activity will likely prolong into Q2," it noted.
Set up GST Council type authorities for land, labour, power to drive structural reforms
The Reserve Bank suggested setting up GST Council type apex authorities for land, labour and power to drive structural reforms and expedite implementation of national infrastructure pipeline.
It said targeted public investment funded by monetisation of assets in steel, coal, power, land, railways and privatisation of major ports by central and state governments under an independent regulator can be the way forward to revive and crowd in private investment.
"In fact, Goods and Services Tax (GST) Council type of apex authorities can be set up in respect of land, labour and power to drive structural reforms," RBI said in its 2019-20 annual report.
The reforms could include speedier implementation of the national infrastructure pipeline, a north-south and east-west road corridor together with a high-speed rail project that builds on the success of the golden quadrilateral, alongside steps to improve business sentiment and environment for investment.
It suggested that states can be encouraged to publicise the availability of litigation-free land in their jurisdictions with access to modern infrastructure.
"In the power sector, the opportunity has arrived to leapfrog India into becoming the world leader in renewable energy by incentivising the domestic production of solar panels and connecting dispersed transmission links with remote areas," it said.
For the sector as a whole, elimination of cross-subsidisation through tariff structure and provision of subsidy, if any, through direct benefit transfer (DBT) should be a priority, along with due consideration to the privatisation of electricity distribution companies (DISCOMS).
(With PTI and IANS inputs)
