2021 is witnessing a K-shaped recovery, with most developed countries seeing higher growth rates while most developing countries are decelerating post the initial growth.
This has resulted in a varied response by the central banks. Few markets like Turkey and Russia have increased their interest rate to control inflationary pressures. At the same time, others like European central banks (ECB) and Chinese central banks maintain an accommodative stance.
The European central bank (ECB) has maintained an accommodative stance with a negative interest rate with the main deposit rate at -0.5%. The bank has increased the inflation target to 2%, indicating it is looking at a dovish stance even in 2022.
In contrast, the federal reserve is looking at pulling out liquidity in 2022 as the fiscal stimulus creates inflationary pressure. The indication of this can be seen within the latest Federal Open Market Committee (FOMC) meeting minutes.
In Asia, the Chinese central bank, in its latest policy, has undertaken liquidity boosting measures which is expected to release 1 trillion Yuan into the Economy. This action points to the concern the Chinese central bank has regarding the impact of the current geopolitical situation on its Economy. Japan has also kept an accommodative stance, with COVID-19 being a key concern given the vaccination rate.
We believe this variance in policy across countries is driven primarily by three key factors:
1. Success in fighting the pandemic through vaccinations
2. Ability to provide a sizeable fiscal stimulus
3. Impact of COVID-19 on critical drivers of economic growth
Countries that have been relatively successful in vaccinating the majority of their population are returning to pre-pandemic levels of economic activity. They see their employment rates rise while the supply chains are normalized. Central banks here are targeting the normalization of rates by the end of this year.
Also, governments that have provided massive fiscal stimulus to bolster initial monetary support have been able to moderate the impact of covid on growth. This has provided the central bank with headroom to increase rates to control inflation.
Finally, export-driven economies that have been able to take advantage of the record commodity prices are experiencing higher growth than consumption-driven economies. Central banks here are prioritizing currency stability.
In the case of India, while we have been able to recover from the devastating second wave, the vaccination coverage required to lift all restrictions is not expected to be reached before the end of 2021. Also, there is limited scope to provide a large fiscal stimulus given India’s fiscal deficit. With consumption which is a crucial driver of economic growth impacted due to second wave and resultant local lockdown, India’s growth is expected to be at 9.5% compared to the previous
estimate of 12.5%.
Given the current scenario, the Reserve Bank of India (RBI) will have to prioritize growth. Most central banks globally have stuck to their dovish stand, with only countries seeing high inflationary pressure raising rates. Globally, central banks, especially in developed countries, are expected to start taking a hawkish stance only by the beginning of 2022.
RBI should also maintain an accommodative stance with a gradual pull back of liquidity measures once sustained economic growth is observed. We expect the government of India to continue its reform push and look at providing additional fiscal stimulus. These measures are expected to accelerate growth once we can lift covid restrictions across sectors and states.
Synchronizing the monetary tightening with economic growth is critical. RBI, just like its global counterparts, has been able to walk the tightrope of balancing growth and inflation. The key going forward will be to identify the right time to rebalance the pole, focusing on shifting from growth to inflation.
The blog has been authored by Nilaya Varma, CEO, Primus Partners and Shravan Shetty, MD, Primus Partners
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