Assisting the Indian economy on its path to recovery

According to the latest GDP forecasts, India’s economy would grow at a rate of 9.2% in 2021-22. This is, however, lower than the Reserve Bank of India’s forecast of 9.5 percent from December of last year. The nominal GDP is expected to increase by 17.6%. These GDP figures, which were released ahead of the Union budget for 2022-23, are significant since they will be included in fiscal projections. By the conclusion of this fiscal year, the economy should have recovered to its pre-Covid level. The country’s growth trajectory, on the other hand, will be largely determined by the government’s fiscal policy, which must take into account the monetary policy’s constraints in starting a recovery.

To deal with the pandemic, the central bank has taken a “whatever it takes” approach. Throughout multiple monetary policy committee (MPC) decisions, the status quo on key policy rates has been maintained. Although the RBI has not yet “officially” declared any “normalization procedure,” it is absorbing surplus liquidity by raising the VRRR (Variable Rate Reverse Repo) cut-off yield rate and reducing the G-sec purchasing program. The liquidity-related stimulus policies enacted so far have had a poor multiplier effect, as Joseph Stiglitz and Hamid Rashid pointed out in their article, ‘Which stimulus works?’ This suggests that credit-related actions alone will not be enough to get a country out of a macroeconomic crisis. However, because there is a risk of an increase in non-performing assets, it is required to absorb the extra liquidity supplied as part of the pandemic response to stimulate the economy (NPAs).

The RBI/MPC is under increasing pressure to raise interest rates in the face of the taper tantrum and probable interest rate hikes by the US Fed to avert a capital flight. Central banks around the world have begun to raise interest rates. In India, however, no definitive decision has been made because a hike in the rate could stymie the recovery.

Inflationary pressures are increasing as well. According to data from the Ministry of Commerce and Industry, inflation in the Wholesale Price Index (WPI) reached a new high of 13.56 percent in December 2021. The Consumer Price Index inflation rate of 5.59 percent in December 2021 is closer to the framework’s upper threshold, although being inside the comfort zone of the inflation-targeting framework’s comfort zone of 4% with a plus/minus 2% band.

Infrastructure spending by the government is a major driver of economic growth. Reducing the fiscal deficit to pre-crisis levels could be harmful to the economy’s recovery. The “fiscal risks” posed by rising public debt and deficits must be addressed with a medium-term fiscal consolidation strategy, as immediate deficit reduction could stymie recovery. Given the limited economic impact of a credit-linked stimulus, fiscal supremacy is crucial. At this point, a more flexible fiscal policy is required to foster recovery.

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