Monetary Policy Report - April 2022

Published under Section 45ZM of the Reserve Bank of India Act, 1934 Monetary Policy Report APRIL 2022 Reserve Bank of India MumbaiContents Chapter I: Macroeconomic Outlook 1 I.1: Key Developments since the October 2021 MPR 1 I.2: The Outlook for Inflation 5 I.3: The Outlook for Growth 9 I.4: Balance of Risks 11 I.5: Conclusion 16 Box I.1: Inflation Expectations Anchoring 6 Chapter II: Prices and Costs 17 II.1: Consumer Prices 18 II.2: Drivers of Inflation 19 II.3: Costs 31 II.4: Conclusion 35 Box II.1: An Analysis of Sensitivity of Output Prices to Input prices 33 Chapter III: Demand and Output 36 III.1: Aggregate Demand 37 III.2: Aggregate Supply 49 III.3: Conclusion 58 Box III.1: Drivers of Private Consumption 38 Box III.2: Private Sector Investment Cycle Drivers: An Investigation with Firm-Level Data 42 Chapter IV: Financial Markets and Liquidity Conditions 59 IV.1: Domestic Financial Markets 59 IV.2: Monetary Policy Transmission 75 IV.3: Liquidity Conditions and the Operating Procedure of Monetary Policy 80 IV.4: Conclusion 84 Box IV.1: Retail Lending Behaviour of Banks 73 Box IV.2: Refinements in the Operating Framework of Monetary Policy in India 81 Box IV.3: Impact of G-Sec Acquisition Programme 82 Chapter V: External Environment 86 V.1: Global Economic Conditions 88 V.2: Commodity Prices and Inflation 91 V.3: Monetary Policy Stance 95 V.4: Global Financial Markets 98 V.5: Conclusion 103 Box V.1: Impact of the Russia-Ukraine War on the Global Macroeconomy 86 Box V.2: Interest Rate Spillovers from the US to Emerging Market Economies 100 iABBREVIATIONS AEs - Advanced Economies CII - Confederation of Indian Industry AEs - Advance Estimates CLI - Composite Leading Indicator AIC - Akaike Information Criterion CMIE - Centre for Monitoring Indian Economy AIDC - Agriculture Infrastructure and Development Cess COVID-19 - Coronavirus Disease 2019 APP - Asset Purchase Programme CP - Commercial Paper ARDL - Autoregressive Distributed Lag CPI - Consumer Price Index ASEAN - Association of Southeast Asian CPI-AL - Consumer Price Index for Nations Agricultural Labourers ASISO - Automated Sweep-in and Sweep-out CPI-IW - Consumer Price Index for Industrial ATM - At the money Workers bbl - Barrel CPI-RL - Consumer Price Index for Rural BCB - Banco Central do Brazil Labourers BE - Budget Estimates CRR - Cash Reserve Ratio BIES - Business Inflation Expectations CU - Capacity Utilisation Survey DCA - Department of Consumer Affairs BIS - Bank for International Settlements. DGCA - Directorate General of Civil Aviation BoE - Bank of England DGCI&S - Directorate General of Commercial BoJ - Bank of Japan Intelligence and Statistics BoR - Bank of Russia DII - Domestic Institutional Investor bps - Basis Points DSI - Directional Spillover Index BRICS - Brazil, Russia, India, China and DW - Durbin-Watson South Africa EBIT - Earnings before Interest and Taxes BSE - Bombay Stock Exchange ECB - European Central Bank CACP - Commission for Agricultural Costs and Prices ECI - Eight Core Industries CCIL - Clearing Corporation of India ECLGS - Emergency Credit Line Guarantee Limited Scheme CD - Certificate of Deposit ECT - Error Correction Term CDS - Credit Default Swap ECTA - Economic Cooperation and Trade CI - Confidence Interval Agreement CiC - Currency in Circulation EMEs - Emerging Market Economies iiiiiiMonetary Policy Report April 2022 EPFO - Employees’ Provident Fund G-Secs - Government Securities Organisation GST - Goods and Services Tax ERRR - Effective Reverse Repo Rate GVA - Gross Value Added FAO - Food and Agriculture Organization H1 - First Half of the Financial Year FBIL - Financial Benchmarks India Pvt. Ltd (April-September) FDI - Foreign Direct Investment H2 - Second Half of the Financial Year (October-March) FE - Final Estimates ICICI - Industrial Credit and Investment Fed - Federal Reserve Corporation of India FEVD - Forecast Error Variance ICR - Interest Coverage Ratio Decomposition IESH - Inflation Expectations Survey of FICCI - Federation of Indian Chambers of Households Commerce and Industry IIF - Institute of International Finance FIMMDA - Fixed Income Money Market and Derivatives Association of India IIP - Index of Industrial Production FIs - Financial Institutions IMF - International Monetary Fund FIT - Flexible Inflation Targeting IND-AS - Indian Accounting Standard FOMC - Federal Open Market Committee INR - Indian Rupee FPI - Foreign Portfolio Investment IOCL - Indian Oil Corporation Limited FRE - First Revised Estimate IPO - Initial Public Offering FRRR - Fixed Rate Reverse Repo IRDAIA - Insurance Regulatory and Development Authority of India FTA - Free Trade Agreement IRFCL - International Reserves and Foreign F-TRAC - FIMMDA Trade Reporting and Currency Liquidity Confirmation System IT - Information Technology FY - Financial Year LAF - Liquidity Adjustment Facility GDP - Gross Domestic Product LFPR - Labour Force Participation Rate GFCE - Government Final Consumption Expenditure LM - Lagrange Multiplier GFCF - Gross Fixed Capital Formation LPG - Liquefied Petroleum Gas GNDI - Gross National Disposable Income LPR - Loan Prime Rate GoI - Government of India LTROs - Long Term Repo Operations G-SAP - Government Securities Acquisition MCLR - Marginal Cost of Funds Based Programme Lending Rate GSCPI - Global Supply Chain Pressure Index MFs - Mutual Funds iivvAbbreviations MGNREGA - Mahatma Gandhi National Rural Ofgem - Office of Gas and Electricity Markets Employment Guarantee Act OFS - Offer for Sale MMRP - Modified Mixed Reference Period OLS - Ordinary Least Squares MOAFW - Ministry of Agriculture and Farmers’ OMC - Oil Marketing Companies Welfare OMO - Open Market Operations MoH&FW - Ministry of Health and Family OPEC - Organization of the Petroleum Welfare Exporting Countries m-o-m - Month-on-Month OTC - Over-the-Counter MOSPI - Ministry of Statistics and Programme PADO - Public Administration, Defence and Implementation Other services MPC - Monetary Policy Committee PBOC - People’s Bank of China MPR - Monetary Policy Report PCE - Personal Consumption Expenditure MSCI - Morgan Stanley Capital International PEPP - Pandemic Emergency Purchase MSEs - Micro and Small Enterprises Programme MSF - Marginal Standing Facility PFCE - Private Final Consumption MSMEs - Micro, Small and Medium Expenditure Enterprises PFCED - Private Final Consumption NAFED - National Agricultural Cooperative Expenditure Deflactor Marketing Federation of India Ltd PLI - Production Linked Incentive NBFCs - Non-Banking Financial Companies PMGKAY - Pradhan Mantri Garib Kalyan Anna Yojana NCAER - National Council of Applied Economic Research PMI - Purchasing Managers’ Index NDS - Negotiated Dealing System POL - Petroleum, Oil and Lubricants NDTL - Net Demand and Time Liabilities POSOCO - Power System Operation Corporation Limited NEER - Nominal Effective Exchange Rate PPAC - Petroleum Planning and Analysis NGNF - Non-Government Non-Financial Cell NPA - Non-Performing Asset PSB - Public Sector Bank NSC - National Savings Certificate PSF - Price Stabilisation Fund NSDL - National Securities Depository PSU - Public Sector Undertaking Limited PvB - Private Sector Banks NSO - National Statistical Office Q1 - First Quarter NSSO - National Sample Survey Office Q2 - Second Quarter OECD - Organisation for Economic Co-operation and Development Q3 - Third Quarter vvMonetary Policy Report April 2022 Q4 - Fourth Quarter UAE - United Arab Emirates q-o-q - Quarter-on-Quarter UDAN - Ude Desh ka Aam Naagrik RBD - Refined Bleached Deodorised UK - United Kingdom RBI - Reserve Bank of India UNCTAD - United Nations Conference on Trade and Development RE - Revised Estimates US - United States REER - Real Effective Exchange Rate US$ - US Dollar RHS - Right Hand Side USDA - United States Department of RL - Rural Labourers Agriculture SAAR - Seasonally Adjusted Annualised Rate UT - Union Territory SCB - Scheduled Commercial Bank VAR - Vector Autoregression SDF - Standing Deposit Facility VAT - Value Added Tax SDL - State Development Loan VRR - Variable Rate Repo SEBI - Securities and Exchange Board of VRRR - Variable Rate Reverse Repo India WAC - Weighted Average Coupon SEZ - Special Economic Zones WACR - Weighted Average Call Money Rate SFB - Small Finance Banks WADR - Weighted Average Discount Rate SIAM - Society of Indian Automobile Manufacturers WADTDR - Weighted Average Domestic Term Deposit Rate SLR - Statutory Liquidity Ratio WALR - Weighted Average Lending Rate SLTRO - Special Long-Term Repo Operations WAM - Weighted Average Maturity SME - Small and Medium Size Enterprise WAR - Weighted Average Rate SPF - Survey of Professional Forecasters WEO - World Economic Outlook STU - Stocks-to-Use WMA - Ways and Means Advances SWIFT - Society for Worldwide Interbank Financial Telecommunications WPI - Wholesale Price Index T-Bill - Treasury Bill WTO - World Trade Organization TLTRO - Targeted Long Term Repo Operation y-o-y - Year-on-Year TSI - Total Spillover Index YTD - Year to Date vviiI. Macroeconomic Outlook The global economic environment has drastically altered, with the escalating geopolitical situation clouding the outlook for both growth and inflation in India and across the world warranting a revision in forecasts. Lingering war and sanctions, elevated oil and commodity prices, prolonged supply chain disruptions, accentuated global financial market volatility emanating from monetary policy shifts in major economies, and renewed waves of COVID-19 across countries pose downside risks to the growth and upside risks to the inflation outlook. I.1 Key Developments since the October 2021 MPR AEs had hardened substantially in anticipation of a faster and steeper tightening of policy rates, but Since the release of the October 2021 Monetary Policy geopolitical risks have imparted high volatility as Report (MPR), the global economic environment has risk sentiment experiences sudden and sizeable drastically altered, with the escalating geopolitical shifts by every passing day. Equity markets have seen situation clouding the outlook for both growth and sharp corrections since the start of the calendar year inflation in India and across the world warranting with the market volatility index rising to a one-year a revision in forecasts. Amidst persisting global high amidst geopolitical tensions. Currency markets supply chain disruptions, elevated energy and input prices and tighter labour markets, apprehensions of have turned highly volatile in response to these heightened global financial and commodity market developments, with the US dollar index reaching its volatility come together in a perfect storm. highest since June 2020 due to flight to safety. Brent crude prices crossed US$ 130 per barrel on March Turning to the domestic economy, real gross domestic 8, 2022 and have hovered in the US$ 100-120 range product (GDP) rose by 8.9 per cent in 2021-22, above since mid-March, posing the biggest risk to India’s its pre-pandemic (2019-20) level by just 1.8 per cent. economic prospects and putting the global recovery Economic activity, which gained strength in Q2:2021- at heightened risk. The Bloomberg commodity index 22 (July-September) with the ebbing of the second spiked by around 10 per cent since the war erupted wave, has lost pace since Q3:2021-22 (October- on February 24 and 52 per cent on a year-on-year basis December), exacerbated by the spread of the Omicron (as on April 5, 2022) as supply concerns exacerbated variant in Q4 (January-March). The beneficial effects across commodities. Gold prices crossed US$ 2,000 per of the rapid ebb of infections have, however, been ounce on safe haven demand before some correction. overwhelmed by the geopolitical conflagration since Global food prices were at an all-time high in February February 2022. Consumer price index (CPI) inflation 2022 and are expected to harden further in view of edged above the upper tolerance band in February potential supply disruptions. 2022 as unfavourable base effects combine with the With inflation turning out to be persistent and onset of supply shocks as conflict escalates. While broad-based and well above targets, major advanced India’s direct trade and financial exposures are economies (AEs) quickened the pace of unwinding modest, indirect spillovers from the slowing global of their ultra-accommodative monetary policies. A economy, the sharp jump in commodity prices across number of emerging market economies (EMEs) have the board and elevated risk aversion and uncertainty been in a tightening mode since 2021, and more are owing to geopolitical developments weigh heavily on expected to follow. Sovereign bond yields in major the outlook. 1Monetary Policy Report April 2022 Monetary Policy Committee: October 2021-March broad-based and decided unanimously to maintain 2022 status quo on the policy repo rate and with a majority of 5 to 1 to continue with the accommodative stance During October 2021-March 2022, the Monetary Policy set out in the October resolution. Committee (MPC) met thrice. When the MPC met for its October 2021 meeting, CPI inflation had returned At the time of MPC’s February 2022 meeting, within the tolerance band after breaching the upper CPI inflation had edged even higher, driven up threshold in May-June 2021. The outlook for aggregate by unfavourable base effects while demand-pull demand was progressively improving but output was pressures remained muted. The MPC noted that still below the pre-COVID level and the recovery inflation was likely to moderate in H1:2022-23 and was uneven. The external environment had turned move closer to the target thereafter, providing room uncertain and challenging, with headwinds from to remain accommodative. The potential pick up of slowing growth in major economies, a steep jump input costs was seen as a contingent risk, especially if in natural gas prices and concerns emanating from international crude oil prices remained elevated. On normalisation of monetary policy in major advanced economic activity, the MPC observed that COVID-19 economies. Against this backdrop, the MPC noted continued to impart some uncertainty to the future that the domestic recovery needed to be nurtured outlook while the global macroeconomic environment assiduously through all policy channels and decided was characterised by deceleration in global demand, unanimously to keep the policy repo rate unchanged with increasing headwinds from financial market at 4 per cent and by a majority of 5 to 1 to continue volatility induced by monetary policy normalisation. with an accommodative stance as long as necessary Judging that the domestic recovery was still to revive and sustain growth on a durable basis and incomplete and needed continued policy support, the continue to mitigate the impact of COVID-19 on MPC decided unanimously to keep the policy repo the economy, while ensuring that inflation remains rate unchanged and on a 5 to 1 majority to continue within the target going forward. with the accommodative stance. In its December 2021 meeting, the MPC noted that The MPC’s voting pattern reflects the diversity in continuing the normalisation of excise duties and individual members’ assessments, expectations and value added taxes (VATs) on petroleum products policy preferences, a characteristic also reflected in alongside measures to address other input cost voting patterns of other central banks (Table I.1). pressures assumed critical importance for a sustained Macroeconomic Outlook lowering of core inflation. The domestic recovery Chapters II and III analyse macroeconomic was gaining traction but was just about catching developments related to inflation and economic up with pre-pandemic levels and downside risks activity during H2:2021-22 (October-March). For remained significant, rendering the outlook highly the updated projections set out in this Chapter, uncertain, especially on account of global spillovers, the evolution of key macroeconomic and financial the potential resurgence in COVID-19 infections with variables over the past six months warrants revisions new mutations, persisting shortages and bottlenecks in the baseline assumptions (Table I.2). and the widening divergences in policy actions and stances across the world. Against this backdrop, the First, international crude oil prices have surged over MPC judged that the ongoing domestic recovery the past six months. Crude oil prices initially declined needed sustained policy support to make it more in late November 2021 in the wake of the Omicron 22Chapter I Macroeconomic Outlook Table I.1 Monetary Policy Committees and Table I.2: Baseline Assumptions for Projections Policy Rate Voting Patterns Indicator MPR October 2021 MPR April 2022 Country Policy Meetings: October 2021-March 2022 Crude Oil US$ 75 per barrel US$ 100 per barrel Total Meetings Meetings Variation (Indian basket) during H2:2021-22 during 2022-23 meetings with full without in policy Exchange rate ` 74.3/US$ during ` 76/US$ during consensus full rate (basis H2:2021-22 2022-23 consensus points) Brazil 4 4 0 550 Monsoon 1 per cent below Normal for 2022-23 long-period average Chile 4 4 0 550 Colombia 4 0 4 300 Global growth 6.0 per cent in 2021 3.5 per cent in 2022 Czech Republic 4 0 4 350 4.9 per cent in 2022 3.5 per cent in 2023 Hungary 6 6 0 275 Fiscal deficit To remain within BE To remain within BE India 3 3 0 0 (per cent of GDP) 2021-22 2022-23 Israel 4 3 1 0 Centre: 6.8 Centre: 6.4 Japan 4 0 4 0 Combined: 10.2 Combined: 9.0 South Africa 3 0 3 75 Domestic macroeconomic/ No major change No major change Sweden 2 2 0 0 structural policies during Thailand 4 4 0 0 the forecast period UK 4 0 4 65 Notes: 1. The Indian basket of crude oil represents a derived numeraire US 4 3 1 25 comprising sour grade (Oman and Dubai average) and sweet Sources: Central bank websites. grade (Brent) crude oil. 2. The exchange rate path assumed here is for the purpose of generating the baseline projections and does not indicate any wave and the expected reduction in demand; since ‘view’ on the level of the exchange rate. The Reserve Bank is guided by the objective of containing excess volatility in the then, global crude oil prices have been on the rise foreign exchange market and not by any specific level of and/or as demand increased with the ebbing of Omicron band around the exchange rate. 3. BE: Budget estimates. infections while supply remained sluggish due to 4. Combined fiscal deficit refers to that of the Centre and States the chronic under-performance versus targets by the taken together. Sources: RBI staff estimates; Budget documents; and IMF. Organization of the Petroleum Exporting Countries (OPEC) plus, a subdued shale response, multi-year low oil inventories, dwindling spare capacity and Russia- about the economic fallout from the Omicron wave, Ukraine developments (Chart I.1). The outlook has elevated crude oil prices, and expectations of faster become highly uncertain due to escalating geopolitical rate hikes by the US Fed. Subsequently, as the Omicron tensions and sanctions, even as the US has decided caseloads declined sharply, the INR showed signs of to release about 180 million barrels of oil from its appreciation. The INR came under pressure from late stockpile in a bid to cool crude prices. Taking into February due to geopolitical tensions and the surge account these developments, crude prices (Indian in crude oil prices. Taking these developments into basket) are assumed at US$ 100 per barrel in the consideration, the exchange rate is assumed at INR 76 baseline, 33 per cent above the October MPR baseline. per US dollar in the baseline as against INR 74.3 in the October 2021 MPR. Second, the nominal exchange rate (the Indian rupee or INR vis-à-vis the US dollar) has exhibited two-way Third, the global economic prospects have weakened movements in a range of INR 74-77 per US dollar significantly since the October MPR, with a sequence since October 2021. The INR exhibited a depreciating of headwinds from the Omicron wave, prolonged bias till the middle of December 2021 over concerns global supply chain disruptions, persistent container 33Monetary Policy Report April 2022 Chart I.1: Crude Oil – Production and Prices a: Major Oil Producing and Exporting Countries b: Brent Prices Note: Data pertain to 2020. Source: CEIC. Source: Bloomberg. shortages, multi-decadal inflation highs in major for 2022 to be 100 bps below its October 2021 advanced economies forcing their central banks to assessment.2 quicken the pace of monetary policy normalisation and more recently by the escalating geopolitical Chart I.2: Global GDP Growth Outlook tensions (Chart I.2). According to the Organisation for Economic Co-operation and Development (OECD), the rise in commodity prices and financial market volatility since the ratcheting up of the geopolitical tensions in February, if sustained, could reduce global GDP growth by over one percentage point in the first year and push up global consumer price inflation by around 2.5 percentage points; the output losses could be higher in case of further sanctions, consumer and business boycotts, disruptions to shipping and air traffic, the unavailability of key products from Russia, trade restrictions such as export bans on food commodities, and undermined consumer confidence.1 Note: IMF data are aggregated on purchasing power parity weights and UNCTAD In March, the United Nations Conference on Trade data are on market exchange rates; the respective months of projections are in parentheses. Sources: IMF; and UNCTAD. and Development (UNCTAD) projected global growth 1 OECD (2022), “Economic and Social Impacts and Policy Implications of the War in Ukraine”, Economic Outlook, Interim Report, March. 2 UNCTAD (2022), “Tapering in a Time of Conflict”, Trade and Development Report Update, March. 44Chapter I Macroeconomic Outlook I.2 The Outlook for Inflation Chart I.3: Inflation Expectations of Households After easing to 4.3 per cent in September 2021, CPI inflation rose in the following months to reach 6.1 per cent in February 2022, driven by the increase in food inflation. Looking ahead, the three months and one year ahead median inflation expectations of urban households increased marginally by 10 bps each in the March 2022 round of the Reserve Bank’s survey.3 The proportion of respondents expecting the general price level to increase by more than the current rate also increased for both the three months and one year ahead horizons vis-à-vis the previous round (Chart I.3). Manufacturing firms polled in the January-March Source: Inflation Expectations Survey of Households, RBI. 2022 round of the Reserve Bank’s industrial outlook survey expected increase in their input costs and selling prices in Q1:2022-23 (Chart I.4a).4 Service and in the pace of increase in input costs and selling prices infrastructure sector companies expected moderation in Q1:2022-23 (Charts I.4b and I.4c).5 The respondents Chart I.4: Expectations about Cost of Raw Materials/Inputs and Selling Prices a. Manufacturing Firms b. Services Firms c. Infrastructure Firms Source: Services and Infrastructure Outlook Source: Services and Infrastructure Outlook Source: Industrial Outlook Survey, RBI. Survey, RBI. Survey, RBI. Note: Net response is the difference between the share of respondents reporting optimism and those reporting pessimism. The range is -100 to 100. A positive/ negative value of net response is considered as optimistic/pessimistic from the view point of respondent firms. Therefore, higher positive values of selling prices indicate increase in output prices while lower values for the cost of raw materials/cost of inputs indicate higher input price pressures and vice versa. 3 The Reserve Bank’s inflation expectations survey of households is being conducted in 19 cities since March 2021 (18 cities in previous rounds) and the results of the March 2022 round are based on responses from 6,033 households. 4 The results of the January-March 2022 round of the industrial outlook survey are based on responses from 1,283 companies. 5 Based on 574 companies polled in the January-March 2022 round of the services and infrastructure outlook survey. 55Monetary Policy Report April 2022 Chart I.5: Professional Forecasters' Table I.3: Projections - Reserve Bank and Projection of CPI Inflation Professional Forecasters (Per cent) 2021-22 2022-23 2023-24 Reserve Bank’s Baseline Projections Inflation, Q4 (y-o-y) 6.2 5.1 5.5 Real GDP growth 8.9@ 7.2 6.3 Median Projections of Professional Forecasters Inflation, Q4 (y-o-y) 6.1 5.2 Real GDP growth 8.8 7.5 Gross domestic saving (per cent of GNDI) 29.0 28.7 Gross capital formation (per cent of GDP) 30.1 30.6 Credit growth of scheduled commercial banks 8.0 9.4 Combined gross fiscal deficit (per cent of GDP) 10.4 9.7 Central government gross fiscal deficit (per 6.9 6.4 cent of GDP) Sources: Survey of Professional Forecasters; RBI; and National Statistical Office. Repo rate (end-period) 4.0 4.5 Yield on 91-days treasury bills (end-period) 3.9 4.5 Yield on 10-year central government 6.8 7.1 in manufacturing and services PMI reported continued securities (end-period) input and output price pressures in March 2022. Overall balance of payments (US$ billion) 42.5 -18.1 Merchandise exports growth 39.0 8.9 Professional forecasters surveyed by the Reserve Merchandise imports growth 53.0 12.9 Bank in March 2022 expected CPI inflation to move Current account balance (per cent of GDP) -1.7 -2.6 from 6.1 per cent in Q4:2021-22 to 5.8 per cent in @: Second advance estimates, National Statistical Office. Q1:2022-23, 5.9 per cent in Q2, 5.4 per cent in Q3 Note: GNDI: Gross National Disposable Income. Sources: RBI staff estimates; and Survey of Professional Forecasters and 5.2 per cent in Q4 (Chart I.5 and Table I.3).6 One- (March 2022). year ahead inflation expectations of professional while those of households seem to be sensitive to forecasters are anchored around the inflation target, volatility in food prices (Box I.1). Box I.1: Inflation Expectations Anchoring Inflation expectations of firms and households are a key the hypothesis – assesses directly whether inflation determinant of actual inflation dynamics. Two facets of expectations are anchored at the inflation target (equation the degree of anchoring of inflation expectations can be 3 below). Drawing upon this conceptual framework, empirically examined – shock and level anchoring (Ball an empirical analysis is undertaken for 4-quarter ahead and Mazumder, 2011; Chen, 2019). Shock anchoring inflation expectations of professional forecasters (SPF) would imply that transitory supply-side shocks and and households (IESH) in the Indian context for the inflation surprises (difference between the realised period October 2016 to February 2022. The analysis is also inflation and prior inflation expectations) do not affect conducted for the pre-pandemic period for robustness, inflation expectations of economic agents (equations given the persistent supply-side shocks in the period 1 and 2 below). Level anchoring – a stronger form of since March 2020. (Contd.) 6 33 panellists participated in the March 2022 round of the Reserve Bank’s survey of professional forecasters. 66Chapter I Macroeconomic Outlook Table I.1.1: Shock Anchoring SPF IESH FIT period FIT period excluding pandemic FIT period FIT period excluding pandemic Core inflation 0.244** 0.240* 0.233** 0.214** 0.687*** 0.596** 0.657*** 0.743*** Food and fuel inflation -0.013 - -0.024 - 0.156** - 0.399*** - Food inflation - -0.012 - -0.020 - 0.130** - 0.288*** Fuel inflation - 0.013 - 0.015 - 0.079 - 0.025 Constant 3.242*** 3.183*** 3.397*** 3.418*** 5.411*** 5.602*** 4.628*** 4.545*** Observations 33 33 21 21 33 33 21 21 Adjusted R2 0.47 0.46 0.74 0.73 0.51 0.48 0.57 0.51 DW Statistic 1.56 1.59 1.47 1.49 1.86 1.82 2.00 1.92 Note: ***, **, * denote the level of significance at 1%, 5% and 10%, respectively. Regression estimates are corrected for first-order serially correlated residuals by using the Prais–Winsten transformation. FIT refers to Flexible Inflation Targeting. Source: RBI staff estimates. …(1) Table I.1.2: Shock Anchoring … (2) SPF IESH … (3) FIT period FIT period FIT period FIT period excluding excluding where is 4-quarter ahead inflation expectations pandemic pandemic formed in period t; and are core, and News shock 0.082 0.030 0.219** 0.442** food and fuel inflation (y-o-y), respectively, available at Constant -0.014 -0.052 0.969** 1.896** the time of the survey; and is the inflation target/ Observations 33 21 33 21 anchor (4 per cent). Core inflation is CPI headline Adjusted R2 0.03 -0.04 0.08 0.15 DW Statistic 1.61 1.52 2.27 2.26 inflation excluding food and fuel.7 A priori, (the degree of sensitivity to transient supply shocks) in equation 1 Note: ***, **, * denote the level of significance at 1%, 5% and 10%, respectively. and (the degree of sensitivity to inflation surprises) in Source: RBI staff estimates. equation 2 are expected to be statistically insignificant impart stability to bond yields and improve monetary for shock-anchored expectations. In equation 3, (the transmission. Inflation expectations of households, degree of alignment with the target) is expected to be positive and statistically significant for level-anchored expectations, with closeness to unity indicative of the Table I.1.3: Level Anchoring degree of anchoring. The results indicate that expectations SPF IESH of professional forecasters are shock-anchored (full FIT FIT period FIT FIT period sample as well as pre-pandemic period), i.e., they are period excluding period excluding pandemic pandemic not influenced by food and fuel price shocks (Tables I.1.1 Target 1.082*** 1.118*** 2.228*** 1.574*** and I.1.2). Inflation 0.027 -0.017 0.169 0.711*** One-year ahead expectations of professional forecasters Observations 33 21 33 21 Adjusted R2 0.87 0.96 0.96 1.00 are also level-anchored (i.e., they remain in close DW Statistic 1.54 1.18 1.96 1.84 proximity to the inflation target); the null hypothesis Wald Test for (cid:533)=1 & 0.27 0.14 0.00 0.00 1 of a unit coefficient on the inflation target and a zero (cid:533) 2=0 (p-value) coefficient on the actual realisation of inflation is not Note: ***, **, * denote the level of significance at 1%, 5% and 10%, respectively. Regression estimates are corrected for first-order serially rejected (Table I.1.3 and Chart I.1.1a). Such anchoring correlated residuals by using the Prais–Winsten transformation. of medium- and long-term inflation expectations can Source: RBI staff estimates. (Contd.) 7 For robustness, the empirical analysis also considered the core measure of inflation excluding food, fuel, petrol and diesel, but the results remained similar. 77Monetary Policy Report April 2022 Chart I.1.1: One-year Ahead Inflation Expectations a: Households' and Professional Forecasters' b: Households' Expectations - Select Countries Expectations - India Sources: Survey of Professional Forecasters; and Inflation Expectations Survey of Households, RBI. Source: CEIC. on the other hand, seem to be adaptive and backward- References: looking, driven by changes in food prices (food items have Ball, Laurence, and S. Mazumder (2011), “Inflation a weight of 46 per cent in the CPI in India) as well as the Dynamics and the Great Recession”, Brookings Papers on relatively more volatile nature of food prices (Singh et al., Economic Activity 42 (Spring), pp. 337–405. 2022). A comparison of the regressions of households for the full period and the pre-pandemic period (Tables I.1.1 Baqaee, David Rezza (2020), “Asymmetric Inflation and I.1.2) indicates a reduction in the coefficients on food Expectations, Downward Rigidity of Wages, and and fuel inflation as well as on inflation surprises in the Asymmetric Business Cycles”, Journal of Monetary extended sample, suggesting reduced sensitivity of their Economics, 114, pp. 174-193. expectations to shocks. An upward bias in households’ Chen, Yiqun Gloria (2019), “Inflation, Inflation inflation expectations is observed in other countries as Expectations, and the Phillips Curve", Congressional well (Chart I.1.1.b). The co-movement of households’ Budget Office Working paper, 2019-07. inflation expectations with actual inflation appears to be in consonance with the cross-country experience with Singh, D. P., Mishra, A., and Shaw, P. (2022), “Taking expectations responding more to an increase in prices Cognisance of Households’ Inflation Expectations in than to an equivalent fall in prices (Baqaee, 2020). India”, RBI Working Paper Series, 02/2022. Looking ahead, the record foodgrains production models, and crude oil (Indian basket) at US$ 100 in 2021-22, ample foodgrains buffer stocks and the per barrel in 2022-23, CPI inflation is projected to government’s supply side interventions augur well average 5.7 per cent in 2022-23 – 6.3 per cent in Q1, for food inflation in 2022-23 on the assumption of 5.8 per cent in Q2, 5.4 per cent in Q3, and 5.1 per a normal monsoon. Taking into account the initial cent in Q4 (Chart I.6). The 50 per cent and the 70 per conditions, signals from forward-looking surveys, cent confidence intervals for headline inflation in estimates from structural and other time-series Q4:2022-23 are 3.4-6.8 per cent and 2.5-7.7 per cent, 88Chapter I Macroeconomic Outlook in global commodity prices due to global demand Chart I.6: Projection of CPI Inflation (y-o-y) weakening more than expected and an easing of geopolitical tensions. I.3 The Outlook for Growth Economic activity which was recovering with the ebbing of the third wave, rapid stride towards universal vaccination, and supportive fiscal and monetary policies now faces significant headwinds from the exacerbating geopolitical developments and the accompanying sharp rise in global commodity prices and weakening global growth outlook. Note: The fan chart depicts uncertainty around the baseline projection Turning to the key messages from forward-looking path. The baseline projections are conditioned upon the assumptions set out in Table I.2. The thick red shaded area represents 50 per cent confidence interval, surveys, the consumer confidence (the current implying that there is 50 per cent probability that the actual outcome will be within the range given by the thick red shaded area. Likewise, for 70 per cent and situation index) rose in the March 2022 survey round, 90 per cent confidence intervals, there is 70 per cent and 90 per cent probability, respectively, that the actual outcomes will be in the range represented by the although it remained in the pessimistic zone. For respective shaded areas. Source: RBI staff estimates. the year ahead, consumers’ optimism strengthened further on the back of improved sentiments on respectively. For 2023-24, assuming a progressive the general economic situation, employment and household income (Chart I.7).8 normalisation of supply chains, a normal monsoon and no further exogenous or policy shocks, structural model estimates indicate that inflation will move in Chart I.7: Consumer Confidence a range of 4.6-5.7 per cent. The 50 per cent and the 70 per cent confidence intervals for Q4:2023-24 are 3.8-7.2 per cent and 2.9-8.1 per cent, respectively. There are a number of upside and downside risks to the baseline inflation forecasts. The upside risks emanate from a further hardening of global crude and other commodity prices due to geopolitical tensions, longer-than-expected supply chain disruptions, a larger pass-through of input cost pressures to output prices in the event of stronger demand conditions and global financial market volatility from a quicker- than-expected normalisation of monetary policy by the advanced economies. The downside risks arise from an early mending of supply chain disruptions, a Source: Consumer Confidence Survey, RBI. muted pass-through to output prices and a correction 8 The Reserve Bank’s consumer confidence survey is being conducted in 19 cities since March 2021 (13 cities in the previous rounds) and the results of the March 2022 round are based on responses from 5,984 respondents. 99Monetary Policy Report April 2022 Chart I.8: Business Assessment and Expectations a. Manufacturing Firms b. Services Firms c. Infrastructure Firms Source: Industrial Outlook Survey, RBI. Source: Services and Infrastructure Outlook Source: Services and Infrastructure Outlook Survey, RBI. Survey, RBI. Optimism in the manufacturing sector for the quarter cent in Q2, 5.1 per cent in Q3, and 4.9 per cent in Q4 ahead moderated marginally in the January-March (Chart I.9). 2022 round of the Reserve Bank’s industrial outlook survey due to an ebb in sentiments on inventory Table I.4: Business Expectations Surveys of raw materials and finished goods (Chart I.8a). Item NCAER FICCI Dun and CII Services and infrastructure sectors also reported Business Overall Bradstreet Business Confidence Business Composite Confidence lower optimism on the overall business situation in Index Confidence Business Index Q1:2022-23 (Charts I.8b and I.8c). (December Index Optimism (March 2021) (January Index (Feb- 2022) Recent surveys by other agencies indicate a sequential 2022) ruary 2022) moderation in business expectations (Table I.4). Current level of 124.4 63.9 89.9 65.0 the index According to the PMI surveys, one year ahead Index as per 117.4 75.7 94.6 66.8 business expectations of firms in the manufacturing previous survey sector moderated while those of firms in the services % change (q-o-q) 6.0 -15.6 -5.0 -2.7 sequential sector remained steady in March 2022. % change (y-o-y) 46.6 -13.9 12.5 -5.4 Professional forecasters polled in the March 2022 Notes: 1. NCAER: National Council of Applied Economic Research. round of the Reserve Bank’s survey expected real GDP 2. FICCI: Federation of Indian Chambers of Commerce & Industry. growth at 3.9 per cent in Q4:2021-22, 14.0 per cent in 3. CII: Confederation of Indian Industry. Sources: NCAER; FICCI; CII; and Dun & Bradstreet Information Services Q1:2022-23 (due to favourable base effects), 6.4 per India Pvt. Ltd. 1100Chapter I Macroeconomic Outlook Chart I.9: Professional Forecasters' Projection of Chart I.10: Projection of Growth in Real GDP (y-o-y) Real GDP Growth Note: The fan chart depicts uncertainty around the baseline projection path. The baseline projections are conditioned upon the assumptions set out in Table I.2. The thick green shaded area represents 50 per cent confidence interval, implying that there is 50 per cent probability that the actual outcome will be within the range given by the thick green shaded area. Likewise, for 70 per cent and 90 per cent confidence intervals, there is 70 per cent and 90 per cent probability, respectively, that the actual outcomes will be in the range represented by the respective shaded areas. Sources: Survey of Professional Forecasters; RBI; and National Statistical Office. Source: RBI staff estimates. Taking into account the baseline assumptions, heightened geopolitical tensions – resulting in the including crude oil (Indian basket) at US$ 100 per significant hardening of international crude oil and barrel, the survey indicators, and model forecasts, other commodity prices to multi-year highs, the real GDP growth is expected at 7.2 per cent in 2022- upsurge in global financial market turmoil and the 23 - Q1:2022-23 at 16.2 per cent; Q2 at 6.2 per cent; loss of momentum in global trade and demand – pose Q3 at 4.1 per cent; and Q4 at 4.0 per cent - with sizeable downside risks to the baseline growth path. risks evenly balanced around this baseline path Additional downside risks emanate from renewed (Chart I.10 and Table I.3). For 2023-24, assuming a COVID-19 infections, new and more contagious normal monsoon, and no major exogenous or policy variants of the virus, pandemic-related global supply shocks, the structural model estimates indicate real bottlenecks stretching longer than expected, and GDP growth at 6.3 per cent, with quarterly growth AE monetary policy normalisation-induced global rates in the range of 5.9-6.8 per cent. financial market volatility. There are upside and downside risks to the baseline I.4 Balance of Risks growth path. Upside risks to the baseline trajectory could emanate from stronger and sustained The baseline projections of inflation and growth expansion in domestic demand, including for contact- presented in the previous sections are conditional on intensive services, a boost to private investment the assumptions of key domestic and international activity from the confluence of government’s thrust macroeconomic variables set out in Table I.2. This on capital expenditure, and healthier corporate section explores plausible alternative scenarios to balance sheets (Chapter III). On the contrary, the assess the balance of risks to the baseline projections. 1111Monetary Policy Report April 2022 (i) Geopolitical Risks baseline, domestic growth and inflation could be around 40 bps and 20 bps, respectively, below the The global recovery from the COVID-19 pandemic baseline trajectories; however, the jump in crude oil is turning out to be muted relative to earlier prices due to geopolitical tensions, as discussed later, expectations. Downside risks to even this subdued would harden domestic inflation. Conversely, an early recovery have jumped significantly from the easing of geopolitical tensions, growing vaccination escalation of geopolitical tensions, which have led coverage across countries, a more even distribution to a broad-based increase in global commodity prices of vaccines towards low-income countries, a faster and are expected to have a large negative impact on easing of supply chain disruptions and a more global trade and growth. Even as the share of Russia gradual withdrawal of monetary accommodation and Ukraine in global economy is modest, they are by the major AEs could provide a boost to economic among the major global suppliers of key commodities activity. In this scenario, assuming that global growth such as crude oil, natural gas, fertilisers, wheat, corn, surprises by 100 bps on the upside, domestic growth and metals. A more protracted conflict, extended and inflation could edge higher by around 40 bps and sanctions, sustained further hardening of global 20 bps, respectively, over the baseline (Charts I.11a commodity prices and prolonged supply bottlenecks and I.12a). could push global growth well below the baseline. (ii) International Crude Oil Prices Recurrent waves of COVID-19 infections amidst new mutants of the virus, uneven vaccination International crude oil prices have risen sharply, progress across countries, and a sharper and deeper driven by sudden and overwhelming disruptions tightening of monetary policy by major AE central caused by war, strong demand and a less than banks to anchor inflation expectations impose proportionate expansion in output by the OPEC plus. further downside risks to the global outlook. In such While future prices and the medium-term outlook for a scenario, if global growth is 100 bps lower than the supplies suggest a correction in crude oil prices in the Chart I.11: Impact of Risk Scenarios on the Baseline Inflation Path a. Crude Oil Prices and Global Demand Shocks b. Exchange Rate and Food Price Shocks Source: RBI staff estimates. 1122Chapter I Macroeconomic Outlook Chart I.12: Impact of Risk Scenarios on the Baseline Growth Path a. Crude Oil Prices and Global Demand Shocks b. Exchange Rate and Food Price Shocks Source: RBI staff estimates. months ahead, this could easily be overwhelmed by have a direct impact on inflation, given the weights of the fallout of the conflict. The outlook poses sizeable petrol and diesel in the CPI basket, which wear off in risks on either side for a net energy importer like a year. Second, indirect effects through cost push and India. An escalation of geopolitical tensions and higher inflation expectations could push up headline further drawdown of global inventories amidst OPEC inflation in the medium run. Third, higher trade and plus production continuing to lag demand could current account deficits in the balance of payments harden international crude oil prices even further and can exert downward impact on the INR exchange rate, US$ 150 per barrel could easily be tested. adding to inflationary pressures. On the output side, higher petroleum prices act as a negative terms of Assuming crude oil price to be 10 per cent above the trade shock to the economy, reduce the consumption baseline of US$ 100 per barrel, domestic inflation and of non-oil items of households and lower profit growth could be higher by around 30 bps and weaker by around 20 bps, respectively, over the baseline. margins of firms, cash flows and investment. The Conversely, crude oil prices could soften below the consequent moderation in aggregate demand helps baseline due to a faster resolution of geopolitical to offset some of the inflationary pressures. On net, tensions, release of emergency stockpiles, a stronger inflation increases and might attract a monetary policy shale production response, and global demand response (Chart I.13). becoming subdued owing to renewed waves of the The impact of crude oil prices on domestic inflation virus. As a result, if the Indian basket of crude prices and output is also conditional on the initial level falls by 10 per cent relative to the baseline, inflation of crude oil prices in view of the retail petroleum could ease by around 30 bps with a boost of 20 bps to product prices containing specific (non-ad valorem) growth (Charts I.11a and I.12a). elements such as excise duty and refining costs which Crude oil prices impact growth and inflation through do not co-move with crude oil prices. Therefore, the multiple channels. First, international crude prices higher the initial level of crude oil prices, the higher 1133Monetary Policy Report April 2022 Chart I.13: Crude Oil Shock, Inflation and Output: Decomposition of Channels a. Inflation Impact b. Output Impact Note: Charts show the impact of 10 per cent increase in crude oil prices (at US$ 100/bbl). Source: RBI staff estimates. is the impact of a given shock on domestic headline (Scenario 1) has only a negligible and temporary impact inflation, imparting non-linearity and time variations on inflation and output, while the adverse impact can (Chart I.14). be substantially higher and more protracted in case Finally, the impact of crude oil prices on the domestic crude oil prices remain at elevated levels for longer economy would also be dependent on the persistence (Scenarios 2 and 3) (Chart I.15). of the oil shock. A transitory shock to crude oil prices Chart I.14: Crude Oil Shock, Inflation and Output: Sensitivity to Level of Crude Prices a. Inflation Impact b. Output Impact 0 0.4 0.35 0.4 0 -0.05 0.3 -0.05 0.3 023 -0.1 -0.1 0.2 0.2 -0.15 0.1 -0.2 -0.15 0.15 0 -0.25 150 0.1 150 -0.2 120 20 120 20 Cru Ud Se D o /i bl bp lr9 ic0 e 60 30 0 5 Quart1 e0 rs 15 0 0.05 Cru Ud Se D o /i bl bp lri9 ce0 60 30 0 5 Qua1 r0 ters 15 -0.25 Note: Charts show the impact of 10 per cent increase in crude oil prices at various levels of crude oil price. Source: RBI staff estimates. 1144 stniop egatnecreP stniop egatnecrePChapter I Macroeconomic Outlook Chart I.15: Crude Oil Shock, Inflation and Output: Sensitivity to the Persistence of the Shock a. Inflation Impact b. Output Impact Note: Crude oil price increases from US$ 100 per barrel to US$ 110 and (a) returns to US$ 100 in one quarter (Scenario 1), (b) returns gradually to US$ 100 over 5 years (Scenario 2), and (c) remains at US$ 110 for 2 years before gradually declining to US$ 100 over another 5 years. Source: RBI staff estimates. (iii) Exchange Rate direct investment could continue. In this scenario, if the INR appreciates by 5 per cent relative to the The INR has exhibited two-way movements over the baseline, inflation and GDP growth could moderate by past six months, reflecting both global and domestic around 20 bps and 15 bps, respectively (Charts I.11b factors. Looking ahead, the protracted geopolitical and I.12b). tensions, the heightened volatility in global financial markets, elevated global sovereign bond yields on the (iv) Food Inflation back of more than currently anticipated monetary Food inflation has risen in recent months, largely policy tightening in major AEs, and new COVID-19 due to adverse base effects. The expected seasonal mutations could lead to a broader risk aversion correction seems to be getting backloaded. Going towards EME assets and net capital outflows. Such forward, however, robust rabi prospects, ample buffer developments can put downward pressure on the stocks of cereals, easing of supply chain bottlenecks INR. Should the INR depreciate by 5 per cent from and effective supply management measures could the baseline, inflation could edge up by around 20 bps soften food inflation more than anticipated, and while GDP growth could be higher by around 15 bps push headline inflation 50 bps below the baseline. through increased net exports; the exchange rate pass- through to inflation can, however, be non-linear and Conversely, hardening global food prices due to time-varying in an environment of high volatility in geopolitical tensions and domestic demand-supply financial and commodity markets (Patra et al, 2018).9 gaps in key food items like pulses and edible oils could On the other hand, given that India is among the lead to upward pressures on food prices and raise fastest growing large economies with relatively better headline inflation by around 50 bps. The baseline growth outlook, strong capital flows led by foreign assumes a normal south-west monsoon in 2022 and 9 Patra, Michael Debabrata, Jeevan Kumar Khundrakpam and Joice John (2018), “Non-Linear, Asymmetric and Time-Varying Exchange Rate Pass-Through: Recent Evidence from India”, Working Paper 02/2018, Reserve Bank of India. 1155Monetary Policy Report April 2022 any deviations in the actual outturn on either side Updated forecasts indicate that headline inflation, as well as unseasonal rains would be a critical factor which was expected to ease from current elevated for the food as well as headline inflation trajectory levels as food inflation gets contained on the back (Charts I.11b and I.12b). of record production and abundant stocks, is now subject to a large geopolitical shock. The escalation I.5 Conclusion of war, continued supply chain disruptions, global Economic activity was recovering from the ebbing of financial market volatility emanating from monetary the Omicron wave when the fallout of the Ukraine- policy normalisation in major advanced economies Russia conflict has overcast the near-term outlook and the evolving COVID-19 trajectory pose downside with heightened uncertainties. Growth and inflation risks to growth and upside risks to the inflation outcomes are at high risk across the world as well as outlook and could get exacerbated significantly by in India. In the face of this extraordinary risk, the the intensification of geopolitical tensions. The positive effects expected from the release of pent- concomitant surge in global oil and commodity prices up demand, especially for contact-intensive services, to multi-year highs has increased risk aversion as the government’s thrust on infrastructure and capital reflected in jumps in financial market volatility and expenditure, congenial financial conditions and these developments could increasingly shape the improving capacity utilisation appear ephemeral. economic prospects globally and for India. 1166II. Prices and Costs Consumer price index (CPI) inflation remained volatile during September 2021 to February 2022. After moderating close to the target rate in September, headline CPI inflaiton rose sequentially to the upper tolerance threshold during January-February 2022 mirroring the movements in food inflation, even as fuel inflation remained elevated and core inflation sticky. Costs of farm and non-farm inputs remained elevated. Growth in nominal rural wages for both agricultural and non-agricultural labourers as well as staff costs in the organised sector remained contained. Since the publication of the October 2021 MPR, food inflation. With international petroleum product headline inflation1 has registered two-way prices on an unrelenting upward trajectory, fuel movements – first, it moderated close to the target at group inflation remained in double digits during 4.3 per cent in September 2021; thereafter, it moved September to December, moderating a little to 9.3 up sequentially to the upper tolerance threshold per cent in January 2022 and further to 8.7 per cent of 6 per cent in January 2022, breaching it at 6.1 in February. Core inflation2 has remained elevated, per cent in February. The movements in headline sticking close to the upper tolerance threshold of 6.0 per cent as cost-push pressures impacted both inflation mirrored the sharp movements in food manufactures and services (Chart II.1). inflation, which oscillated between a low of 1.6 per cent in September 2021 and a peak of 5.9 per cent in The Reserve Bank of India (RBI) Act enjoins the RBI to February 2022. A combination of transitory supply set out deviations of actual inflation outcomes from dislocation shocks, elevated import price pressures projections, if any, and explain the underlying reasons and unfavourable base effects drove the surge in thereof. The October 2021 MPR projected inflation Chart II.1: CPI Inflation (y-o-y) Note: The imputed CPI prints for April and May 2020 have been regarded as a break in the CPI series. Sources: National Statistical Office (NSO); and RBI staff estimates. 1 Headline inflation is measured by year-on-year changes in the all-India consumer price index (CPI) produced by the National Statistical Office (NSO). 2 Core CPI, i.e., CPI excluding food and fuel is worked out by eliminating the groups ‘food and beverages’ and ‘fuel and light’ from the headline CPI. 1177Monetary Policy Report April 2022 to moderate to 4.5 per cent in Q3:2021-22 before as the seasonal correction in some vegetable increasing to 5.8 per cent in Q4:2021-22. Actual inflation prices materialised as anticipated; but it turned outcomes were higher than projections by around out to be shallower, resulting in the overshoot over 50 bps in Q3, but the gap narrowed to 20 bps in Q4 projections. Moreover, cereal prices were provided (Chart II.2). The overshoot in Q3 was primarily some upside, by rising export unit values – India on account of vegetables prices shooting up is the world’s largest exporter of rice; it has also disproportionately and falling out of alignment with exported 19.1 million tonnes of rice during April 2021 projections in the months of October-November 2021 to February 2022. as a result of crop damage from heavy unseasonal II.1 Consumer Prices rainfall. In addition, crude oil prices, which were The sequential rise in CPI inflation from September assumed to be at US$ 75 per barrel during H2:2021-22, 2021 was initially driven up by a pick-up in price averaged US$ 82 per barrel in October itself, pushing momentum, followed by adverse base effects even as domestic pump prices to the then historic high price momentum declined.4 In October and November levels3 by the beginning of November. Subsequent 2021, price momentum increased across food and reductions in excise duties and State value-added core categories, but this was couched by favourable taxes (VATs) in early November led to a reduction in base effects in food prices. With the winter setting pump prices. Thereafter, barring tax cuts, pump prices in, a sharp correction in food prices caused the price remained unchanged in rest of Q3 even as crude oil momentum to decline in December 2021, but this was prices moderated. In Q4 (up to February 2022), actual more than offset by large unfavourable base effects, outcomes have turned out to be closer to projections, resulting in headline inflation hardening by 75 basis points. In January 2022, the decline in food price Chart II.2: CPI Inflation (y-o-y): Projection versus Actual momentum deepened, but adverse base effects pushed up headline inflation to 6.0 per cent. In February, the CPI headline price momentum turned positive on price pressures from fuel and core categories even though the food price momentum remained negative (Chart II.3). The distribution of CPI inflation during the financial year reveals a high dispersion of inflation rates in the CPI basket, with a considerable positive skew co-existing with a sharp rise in volatility. The large positive skew reflected outliers – oils and fats, fuel and transport – which registered inflation in *: Projections for entire Q4:2021-22 vis-a-vis actual average inflation during double digits. The increase in volatility reflected January-February 2022. Sources: NSO; and RBI staff estimates. surges and sharp deflation in vegetables prices 3 Retail selling price (RSP) for petrol was at ` 110.76 per litre on November 2, 2021 and for diesel, the RSP was at ` 102.30 per litre on November 1, 2021, based on the average RSPs of Indian Oil Corporation Limited (IOCL) in the four major metros (Delhi, Kolkata, Mumbai and Chennai). 4 A change in CPI year-on-year (y-o-y) inflation between any two months is the difference between the current month-on-month (m-o-m) change in the price index (momentum) and the m-o-m change in the price index 12 months earlier (base effect). For more details, see Box I.1 of the MPR, September 2014. 1188Chapter II Prices and Costs Chart II.3: CPI Inflation – Momentum and Base Effects a: CPI Headline b: CPI Food and Beverages c: CPI Fuel and Light d: CPI excluding Food and Fuel Note: The y-o-y inflation for April and May 2021 have been calculated based on the imputed index for April and May 2020 released by NSO. Sources: NSO; and RBI staff estimates. (Chart II.4). Diffusion indices increased sharply during various macro-factors that drove inflation dynamics, January-February 2022 across goods and services, indicate that the inflationary pressures in H2:2021-22 indicating a broadening of price pressures (Chart II.5).5 can be attributed mainly to adverse cost-push factors, coming from supply-side shocks in food and fuel II.2 Drivers of Inflation prices, even as weak aggregate demand conditions A historical decomposition of inflation using vector continued to exert downward pressure on inflation autoregression (VAR) estimates6, to ascertain the (Chart II.6a). 5 The CPI diffusion index, a measure of dispersion of price changes, categorises items in the CPI basket according to whether their prices have risen, remained stagnant or fallen over the previous month. A reading above 50 for the diffusion index signals a broad expansion or generalisation of price increases and a reading below 50 signals broad-based price decline. 6 Historical decomposition estimates the contribution of each shock to the movements in inflation over the sample period (Q4:2010-11 to Q4:2021-22) based on a vector autoregression (VAR) with the following variables (represented as the vector Y) – crude oil prices; exchange rate (INR per US$), asset t price (BSE Sensex), CPI; the output gap; rural wages; the policy repo rate; and money supply (M). All variables other than policy repo rate are growth rates. 3 The VAR can be written in reduced form as: Y =c + A Y + e; where e represents a vector of shocks. Using Wold decomposition, Y can be represented t t-1 t t t as a function of its deterministic trend and sum of all the shocks e. This formulation facilitates decomposition of the deviation of inflation from its t deterministic trend into the sum of contributions from various shocks. 1199Monetary Policy Report April 2022 Chart II.4: Average CPI Inflation (y-o-y) Chart II.5: Diffusion Indices: CPI (Kernel Density Estimates) (M-o-M Seasonally Adjusted) Note: The period 2020-21 refers to June-March. Sources: NSO; and RBI staff estimates. Sources: NSO; and RBI staff estimates. The pick-up in inflation since September 2021 up till October, but declined thereafter, reflecting was driven largely by goods inflation, particularly primarily the movement in petroleum products perishables such as vegetables (non-durable goods with inflation (Chart II.6b). Durable goods inflation has a 7-day recall7). The contribution of semi-perishable transmitted heightened cost-push pressures in the goods (non-durable goods with a 30-day recall) edged manufacturing sector. Chart II.6: Drivers of CPI Inflation a: Decomposition of CPI Inflation* * Deviation from deterministic trend. Note: Estimated using a vector autoregression (see footnote 6 for details). Sources: NSO; RBI; Petroleum Planning & Analysis Cell (PPAC); BSE; Labour Bureau; and RBI staff estimates. (Contd.) 7 The CPI weighting diagrams use the modified mixed reference period (MMRP) data based on the 2011-12 Consumer Expenditure Survey conducted by the National Sample Survey Office (NSSO). Under MMRP, data are collected on expenditure incurred for frequently purchased items – edible oil, eggs, fish, meat, vegetables, fruits, spices, beverages, processed foods, pan, tobacco and intoxicants – during the last seven days; for clothing, bedding, footwear, education, medical (institutional), durable goods, during the last 365 days; and for all other food, fuel and light, miscellaneous goods and services including non-institutional medical services, rents and taxes, data relate to the last 30 days. 2200Chapter II Prices and Costs b: Contribution of Goods and Services c: Contribution of Imported Inflation Note: Figures in parentheses indicate weights in CPI. Sources: NSO; and RBI staff estimates. The increase in international prices of precious declines during November 2021 to January 2022 metals, edible oil and petroleum products led to have not proved sufficient to meaningfully offset the an increase in the contribution of imported sustained price increases seen in the earlier part of components to headline inflation – from 1.8 the year, resulting in the price build-up remaining percentage points (or 40.4 per cent) in October to 2.1 much above historical averages (Chart II.8). percentage points (41.9 per cent) in November 2021. Prices of cereals (weight of 9.7 per cent in headline The decline in international commodity prices in CPI and 21.1 per cent in the CPI food and beverages December contributed to lower imported inflation. group), on a year-on-year basis, emerged out of eight The cut in central excise duties on petrol and diesel months of deflation in October 2021 and reached during November, and the series of cuts in edible oils 4.0 per cent in February 2022. Within cereals, wheat import duties helped in containing the contribution prices have increased sharply since September on of domestically generated inflation pressures higher exports (336.8 per cent y-o-y increase during (Chart II.6c). April 2021-January 2022) and larger procurement. The increase in production (1.6 per cent as per Food 2021-22 second advance estimate (AE) over 2020-21 Food and beverages (weight of 45.9 per cent in the CPI final estimates (FE), ample buffer stocks (1.5 times basket) inflation rose steadily between September the buffer norms as on March 16, 2022) and free 2021 and February 2022. The food price build-up in distribution under Pradhan Mantri Garib Kalyan 2021-22 (up to February) was higher than historical Anna Yojana (PMGKAY) helped contain inflation. In patterns, driven by vegetable and edible oil prices the case of rice, prices remained relatively stable, as even as protein-based products (milk, egg, meat and the pick-up in exports (by 28.2 per cent y-o-y during fish, and pulses), cereals, fruits and prepared meals April 2021-January 2022) was supported by higher experienced lower food price build-ups (Chart II.7a production (2.9 per cent as per 2021-22 2nd AE over and b). In case of edible oil prices, however, the price 2020-21) and buffer stocks (7.5 times the norm). 2211Monetary Policy Report April 2022 Chart II.7: CPI Food Inflation a: Drivers of CPI Food Inflation b: Drivers of CPI Food Momentum *: Includes meat and fish, egg, milk and pulses. **: Includes fruits, sugar, non-alcoholic beverages and prepared meals. Note: Figures in parentheses indicate weights in CPI food and beverages. Sources: NSO; and RBI staff estimates Vegetables prices (weight of 6.0 per cent in headline started receding from December, but adverse base CPI and 13.2 per cent in the CPI food and beverages effects drove up inflation in this category to 6.1 per group) were in deflation under the weight of large cent in February 2022 (Chart II.9). favourable base effects during September-December Among the inflation-sensitive vegetables, onion 2021, despite price pressures due to excess rain prices hardened during October-November 2021 induced crop damage. Vegetables prices, however, on account of damages to the stored rabi crop in Chart II.8: Financial Year Price Build-up (February over March) Note: Figures in parentheses indicate weights in CPI- food and beverages. 2222Chapter II Prices and Costs prices also escalated during October-November Chart II.9: Drivers of Vegetable Inflation (y-o-y) 2021 on account of unseasonal rains. Fresh crop arrivals and ample stocks in cold storages have, however, kept price pressures subdued in subsequent months. Tomato prices also picked up sharply during the same period due to delay in arrivals on account of erratic rains in Punjab, Uttar Pradesh, Haryana and Himachal Pradesh, coupled with supply shortages because of heavy rains in major producing states — Tamil Nadu, Andhra Pradesh, Telangana and Karnataka. Inflation in prices of fruits (weight of 2.9 per cent in the headline CPI and 6.3 per cent within the food and beverages group) moderated from a three-year high of Note: Item level data were not released by NSO for the months of March, April and May 2020. Source: NSO; and RBI staff estimates. 11.8 per cent in May 2021 to 2.3 per cent in February 2022, owing to decline in prices of bananas and apples, with apple production higher by 7.1 per cent in Maharashtra and Gujarat from cyclone Tauktae 2021-22 (1st AE) over 2020-21 (FE). in May 2021, followed by damages to kharif crops due to heavy rains in major producing states. The record production of pulses during Subsequently, prices softened as a result of effective 2021-22 at 269.6 lakh tonnes (2nd AE) has supply side interventions – 2.1 lakh tonnes of onion significantly augmented availability. The higher were released under the price stabilisation fund stock-to-use (STU) ratio at end-March 2022 over last (PSF) scheme and exports were reduced ((-) 8.5 per March is reflective of improved supply conditions cent y-o-y during April 2021-January 2022). Potato (Chart II.10). Supply-side measures such as moving Chart II.10: Pulses Inflation and Stock-to-Use Ratio: Monthly Balance Sheet Sources: MOSPI; DGCIS; CACP; Ministry of Agriculture; and RBI staff estimates. 2233Monetary Policy Report April 2022 imports of tur, urad and moong from restricted Chart II.11: Movement in Edible Oil Inflation: to ‘free category’ from May 15, 2021; removing Global vs Domestic import duty on masur and reducing Agriculture Infrastructure and Development Cess (AIDC) to 10 per cent from July 27, 2021; releasing masur from buffer stocks at discounted price; higher imports of pulses (1.9 per cent y-o-y during April 2021-January 2022); and open market intervention by the National Agricultural Cooperative Marketing Federation of India (NAFED) helped to keep pulses price inflation (weight of 2.4 per cent in the CPI and 5.2 per cent in the food and beverages group) on a moderating trajectory since September 2021. As regards to animal-based protein items, prices declined in the case of meat and fish (weight of Sources: World Bank Pink Sheet; NSO; and RBI staff estimates. 3.6 per cent in the CPI and 7.9 per cent within the food and beverages group) largely during September (Chart II.11). Some important steps taken to ebb price 2021-January 2022, primarily reflecting easing feed pressures include imposition of stock limits on edible costs with the import of 12 lakh tonnes of genetically oils and oilseeds pan India, except for six states (Bihar, modified soya meal and gradual normalisation of Himachal Pradesh, Karnataka, Rajasthan, Telangana supplies. Prices increased in February 2022 due to and Uttar Pradesh which imposed their own stock winter demand. In the case of eggs, price pressures limit order) up to June 30, 2022, and significant set in during November 2021-January 2022 and eased reduction in import duty in a gradual manner on palm in February in accordance with the usual seasonal oil, soyabean oil and sunflower oil. Overall, during pattern. Inflation in milk and products gradually the period from October 2021 to February 2022, the increased to 4.1 per cent in January 2022, before effective import duty on the three major imported easing to 3.8 per cent in February 2022 on favourable crude edible oils, viz. palm oil, soyabean oil and base effects, due to successive upward revisions in sunflower oil, was reduced by 19.25 percentage points milk prices by milk co-operatives in various states to a weighted average of 5.5 per cent. During the same after July 2021, following the increase in prices by around `2 per litre by major milk co-operatives like period, the effective import duty of RBD palmolein/ Amul and Mother Dairy. RBD palm oil and refined soyabean/ sunflower oil was also reduced by 22.0 percentage points and Inflation in prices of oils and fats (weight of 3.6 per 16.5 percentage points, respectively, to 13.75 and cent in the CPI and 7.8 per cent within the food and 19.25 per cent. beverages group) continued to rule in double digits since September 2021 albeit with some moderation Prices of sugar and confectionery (weight of 1.4 on the back of supply-side measures and improved per cent in the CPI and 3.0 per cent in the food prospects for the rabi crop (rabi oilseeds production and beverages group) emerged out of deflation in was higher by 9.1 per cent as per 2nd AE 2021-22) September 2021 and averaged 5.2 per cent during and moderation in international prices of edible oils September 2021 to February 2022, reflecting, higher 2244Chapter II Prices and Costs exports (54.0 per cent y-o-y in April 2021-January cooked snacks as increased input costs fed through. 2022, as per DGCIS), the government’s enhanced For non-alcoholic beverages, tea prices rose on lower target of 10 per cent ethanol blending (against 8.5 per production and higher consumption. In the case of cent earlier) and adverse base effects. Prices declined spices, price pressures emerged since December 2021 during December 2021-February 2022 due to the onset on account of production shortfalls. of domestic production season, coupled with the Retail Margins decision to extend the sale of unsold sugar quota of The retail price margin8, defined as the difference of previous months in November 2021 and January 2022 retail and wholesale prices, for cereals, pulses, and and moderation in international sugar prices since edible oil remained elevated till March 2022. On the December 2021. other hand, margins in the case of vegetables softened, Among other food items, prices hardened in the particularly for tomatoes, as per the seasonal pattern, case of prepared meals, driven by cooked meals and but remained higher than in the past (Chart II.12). Chart II.12: Retail, Wholesale Prices and Margin a: Cereals b: Pulses c: Vegetables d: Edible Oil Sources: Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution; and RBI staff estimates. 8 Item level retail and wholesale prices are aggregated at respective subgroup using item level CPI weights. Data for January-March 2021 have been excluded due to changes in price collection mechanism and item varieties by DCA. 2255Monetary Policy Report April 2022 Impact of the Russia Ukraine War on Domestic Food inflation moderated sequentially to 8.7 per cent Prices in February 2022, enabled by the abrupt slip in electricity prices to deflation since November and The Russia-Ukraine conflict poses considerable upside LPG prices remaining unchanged since October risks to prices of key food items. Even as adverse 2021. Kerosene prices moderated during December spillovers through direct trade remain limited (Chapter 2021-January 2022, reflecting the fall in international III), the Russia-Ukraine war may have a significant prices. In February, as international prices picked up impact on inflation through the global commodity and pass-through became evident, domestic prices markets channel (Chapter V). also registered a sharp increase. LPG prices were also In the case of edible oils, the loss of supplies of increased by `50 per cylinder on March 22, 2022. sunflower oil from Black Sea region is likely to keep Core domestic prices under pressure. The Black Sea region accounts for around 75 per cent of global production Core inflation, i.e., CPI inflation excluding food of sunflower oil and is a key supplier to India. The and fuel, remained elevated at around 6 per situation is being compounded by the tightness in cent in 2021-22 as relentless cost-push pressures global soybean market and the increase in export impinged on goods and services selling prices levies as well as export restrictions by key producing (Table II.1). countries. On the other hand, the significant increase in domestic mustard production is likely to provide Table II.1: Exclusion-based Measures of Inflation (y-o-y) some cushion to the price pressures. Period Exclusion based measures Russia and Ukraine account for about a quarter of global wheat exports. Since the beginning of the CPI excluding CPI excluding CPI excluding food food and fuel food fuel petrol fuel petrol diesel Ukraine war, international wheat prices have soared. (47.3) diesel (45.0) gold silver (43.8) India is not an importer of wheat, but exports from Jun-19 4.1 4.6 4.6 India have picked up sharply in the current year Sep-19 4.2 4.9 4.5 Dec-19 3.8 3.7 3.3 (336.8 per cent y-o-y during April 2021-January 2022). Mar-20 3.9 Therefore, international prices could set a floor for Jun-20 5.4 5.3 4.6 domestic wheat prices through the export channel, Sep-20 5.4 5.2 4.5 Dec-20 5.6 5.3 4.7 even if domestic prices do not move in sync with global Jan-21 5.5 5.2 4.7 prices. However, ample stocks along with a bumper Feb-21 6.0 5.5 5.1 production may help to keep any price increase range Mar-21 5.9 bound. Apr-21 5.3 May-21 6.6 Fuel Jun-21 6.1 5.3 5.4 Jul-21 5.8 5.1 5.3 Fuel inflation surged from 12.9 per cent in August Aug-21 5.8 5.1 5.6 2021 to 13.6 per cent in September and further to Sep-21 5.9 5.2 5.6 14.3 per cent in October, reaching new peaks in Oct-21 5.9 5.0 5.4 Nov-21 6.2 5.5 5.7 these three consecutive months (Chart II.13a). Dec-21 6.1 5.6 5.9 The key driver of this pick-up was the sharp rise Jan-22 6.0 5.6 5.8 in international prices of kerosene and liquefied Feb-22 5.8 5.6 5.7 petroleum gas (LPG) and its transmission to domestic Note: (1) Figures in parentheses indicate weights in CPI. (2) Derived as residual from headline CPI. prices (Chart II.13b and c). From November, fuel Sources: NSO; and RBI staff estimates. 2266Chapter II Prices and Costs Chart II.13: CPI Fuel Group Inflation a: Drivers (y-o-y) *: Includes diesel [excl. conveyance], coke, coal, charcoal and other fuels. Note: Figures in parentheses indicate weights in CPI - fuel and light. b: Kerosene: Domestic and International Prices c: LPG: Domestic and International Prices Notes: (1) The international price for LPG is based on spot prices for Saudi Butane and Propane, combined in the ratio of 60:40, respectively. These international product prices are indicative import prices. Further details are available at www.ppac.org.in. (2) The indicative international price for kerosene is the Singapore Jet Kero spot price. (3) The domestic prices of LPG and kerosene represent the average prices at the four metros from Indian Oil Corporation Limited (IOCL). Domestic prices of LPG are monthly average prices. Sources: NSO; Bloomberg; IOCL; and RBI staff estimates. Core inflation was sticky and higher than in the pre- 2020-21 (June 2020 to March 20219) shows that core COVID period during 2021-22, with elevated core price goods as well as core services inflation were higher in pressures coexisting with significantly lower volatility 2021-22. Also, inflation rates across core sub-groups, than a year ago (Chart II.14). barring housing and education, were higher than in A comparative assessment of the drivers of core 2020-21. Transport and communication, in addition inflation in 2021-22 (April-February) vis-à-vis to health, remained the key drivers, as in 2020-21. pre-COVID years (i.e., 2017-18 to 2019-20) and While the contribution of clothing and footwear to 9 The inflation prints of April and May 2020 were not available due to country-wide lockdown. 2277Monetary Policy Report April 2022 Chart II.14: CPI excluding food and Chart II.15: Contribution to CPI excluding Food fuel: Pre-pandemic and post-pandemic Fuel (Core) Inflation (in percentage points) Note: (1) Figures in parentheses indicate weights in CPI. (2) Derived as residual from headline CPI. Sources: NSO; and RBI staff estimates. Sources: NSO; and RBI staff estimates. overall core inflation edged up sharply in 2021-22, prices to domestic pump prices, petrol and diesel the contribution of personal care and effects declined retail selling prices have registered a cumulative (Chart II.15). increase of around `10 per litre in 14 revisions so far (till April 6, 2022). A key source of core inflationary pressures during September 2021 to February 2022 has been petrol Various measures of core inflation have remained and diesel. Some softening since November was elevated in a range of 5.0-6.2 per cent during facilitated by the cut in central excise duties on September 2021-February 2022 (Table II.1). petrol by `5 per litre and on diesel by `10 per Decomposing CPI excluding food, fuel, petrol, diesel, litre on November 4, 2021 along with a reduction gold and silver into its goods and services components in State VATs in petrol and/or diesel by 28 States/ points to contrasting movements. Inflation in the UTs during November-December 2021. As a result, goods component (with a weight of 20.7 per cent pump prices scaled down from historic highs in the headline CPI) increased consecutively from recorded during November 1-3, 2021. However, Oil August 2020, reaching 7.0 per cent in November 2021 Marketing Companies (OMCs) after adjusting for and plateauing thereafter. This was driven primarily the tax cuts kept the retail selling prices unchanged by clothing and footwear – readymade garments and till the third week of March, even as international uniforms; health care goods —medicines, household crude oil prices exhibited two-way movement – a goods and personal care items and toiletries moderation during December 2021 before reversing (Chart II.17a). On the other hand, services inflation course since early January 2022 and a precipitous (with a weight of 23.0 per cent in the headline CPI) rise from end-February on Russia-Ukraine conflict which was at 4.5 per cent in August 2021, softened (Chart II.16). Since March 22, with OMCs commencing to 4.2 per cent in October before firming up to 4.7 the pass-through of high international crude oil per cent during December 2021-February 2022 2288Chapter II Prices and Costs Chart II.16: Petrol and Diesel Prices a: Petrol - Domestic and International Prices b: Diesel - Domestic and International Prices Note: International petrol and diesel prices denote the spot price of Singapore gasoline and gasoil, respectively. Domestic petrol and diesel prices represent the average pump prices of four metros as reported by Indian Oil Corporation Limited (IOCL). Sources: PPAC; NSO; Ministry of Commerce and Industry; and RBI staff estimates. (Chart II.17b). The pick-up in services inflation was charges during December 2021-January 2022. The on account of the transport and communication sub- contribution of household services (which includes group, coming from an increase in mobile telephone domestic servant/cook/sweeper charges, monthly Chart II.17: Contributions to CPI Inflation excluding Food, Fuel, Petrol, Diesel, Gold and Silver a: Goods b: Services Note: Figures in parentheses indicate weights in CPI. Sources: NSO; and RBI staff estimates. 2299Monetary Policy Report April 2022 maintenance charges) and recreation and amusement (Table II.1). Inflation measured by trimmed means services (cinema; club; hotel lodging charges) also also edged up during this period (Table II.2). increased during this period. The contribution of Other Measures of Inflation services to core inflation continued to remain lower, Inflation measured by sectoral CPIs for agricultural on an average, than what was seen in the pre-pandemic labourers (CPI-AL) and rural labourers (CPI-RL) has period, particularly on account of relatively subdued persisted below CPI headline inflation for the past growth in house rentals (Chart II.15). 20 months. By February 2022, however, the extent In order to filter noise out of CPI inflation, two of divergence gradually narrowed. Both food and fuel common approaches are (i) excluding a fixed set inflation were generally lower in the CPI-AL and CPI- of components from the CPI basket that display RL vis-à-vis CPI, resulting in lower inflation prints. volatile price movements, and (ii) excluding different Inflation in terms of the CPI for industrial workers components each month if they are located in the (CPI-IW) has moved broadly in line with the headline tails of the inflation distribution. The exclusion- CPI during September to January 2022. In February based measures show high and persistent inflationary 2022, however, there was a substantial divergence pressures during September 2021-February 2022 on account of lower food inflation in CPI-IW vis-à-vis headline CPI. Table II.2: Trimmed Mean Measures of Inflation (y-o-y) WPI inflation, which was in double digits since the start of 2021-22, edged up further since September Month 5% 10% 25% Weighted trimmed trimmed trimmed Median 2021, reaching an all-time high of 14.9 per cent (as Jun-19 3.0 3.1 3.0 2.8 per the WPI series, 2011-12=100) in November 2021. Sep-19 3.3 3.2 3.1 2.8 A sharp and broad-based surge in price momentum, Dec-19 4.4 4.0 3.7 4.0 despite strong favourable base effects, drove the Mar-20 Jun-20 5.8 5.4 5.1 4.9 pick-up in WPI inflation. Persistently high WPI core10 Sep-20 6.2 5.6 4.7 5.1 inflation, which remained in double digits from Dec-20 5.6 5.1 4.3 4.0 May to December 2021, reflected high commodity Jan-21 5.0 4.8 4.0 3.6 and input price pressures as well as supply-side Feb-21 5.1 4.9 4.1 3.7 Mar-21 disruptions. WPI inflation moderated somewhat to Apr-21 14.3 per cent and further to 13.0 per cent in December May-21 2021 and January 2022, respectively, before picking Jun-21 5.7 5.2 5.0 5.2 Jul-21 5.8 5.3 5.0 4.6 up marginally to 13.1 per cent in February 2022. Aug-21 5.5 5.1 4.9 4.3 In line with WPI inflation, the deflators for gross Sep-21 5.0 4.9 4.8 4.3 value added (GVA) and gross domestic product Oct-21 5.2 4.9 4.7 4.6 (GDP) remained elevated between Q1:2021-22 to Nov-21 5.5 5.1 5.0 5.0 Dec-21 5.8 5.4 5.2 4.7 Q3:2021-22. Jan-22 5.9 5.6 5.3 5.1 Feb-22 6.0 5.7 5.3 5.6 In H2:2021-22, WPI and CPI inflation have diverged markedly (Chart II.18a). During September 2021 Sources: NSO; and RBI staff estimates. 10 WPI Non-Food Manufactured Products. 3300Chapter II Prices and Costs Chart II.18: Alternative Measures of Inflation a: Various Measures of Inflation (y-o-y) b: CPI-WPI Divergence: Select Commodities (Average during September 2021 - February 2022) Note: For Q4:2021-22, the implicit GDP and GVA deflators were used. Sources: NSO; Labour Bureau; Ministry of Commerce and Industry; and RBI staff estimates. chain in the form of logistics bottlenecks, increase in to February 2022, all the major subgroups of WPI, shipping costs, and longer delivery times resulted in namely, food, fuel and excluding food and fuel (core) input cost pressures. remained substantially above the corresponding subgroups in the CPI. Year-on-year growth in prices of The firming up of global crude oil prices was the main petrol and diesel diverged considerably between CPI factor that impacted the prices of industrial inputs and WPI (Chart II.18b) as the CPI, which records prices such as naphtha, aviation turbine fuel, bitumen, inclusive of taxes, moderated following the reduction petroleum coke and furnace oil. They also contributed in excise duties and State VATs in November- to double-digit inflation in high-speed diesel, which December 2021. Among food sub-groups, fruits and in turn drove up farm input price inflation. Other eggs registered higher price increases on a y-o-y basis contributory factors comprise fertiliser prices that in the WPI relative to the CPI. In the WPI, vegetable edged up in sympathy with international prices, inflation remained elevated whereas in the CPI, prices and prices of some non-food articles that remained of vegetables recorded deflation during September- in double digits – raw cotton and oilseeds. Price of electricity – a key input in both industrial and farm December 2021, before turning up. inputs – also increased sharply during the period in II.3 Costs line with revival in demand. Inflation in industrial Costs, as measured by WPI inflation in industrial raw raw materials and farm inputs, however, eased during materials and farm inputs, remained elevated during December 2021-January 2022 on account of softer H2:2021-22 (Chart II.19). Disruptions in global supply prices of petroleum products but picked up again in 3311Monetary Policy Report April 2022 aluminium and nickel prices rising to highest level in Chart II.19: Farm and Non-farm Input Cost the last decade. Russia is one of the largest producers Inflation (y-o-y) of aluminium, widely used in transportation and construction industry, and of nickel, mostly used for high grade steel manufacturing and in batteries. Further geopolitical tension in the region is likely to aggravate global chip shortage and could impact prices of vehicles and electronic products. Nominal rural wages for both agricultural and non- agricultural labourers picked up during H2:2021-22, with easing of restrictions/lockdowns imposed by * : Comprise primary non-food articles, minerals, coal, aviation turbine fuel, high states and restoration in economic activity. However, speed diesel, naphtha, bitumen, furnace oil, lube oil, petroleum coke, electricity, the wage growth remained soft (Chart II.20). cotton yarn and paper and pulp from WPI. $ : Comprise high speed diesel, fodder, electricity, fertilisers, pesticides, and agricultural and forestry machinery from WPI. In the organised sector, staff cost growth (y-o-y) for Sources: Ministry of Commerce and Industry; and RBI staff estimates. both manufacturing and services picked up in Q1 of 2021-22 but decelerated for manufacturing and February 2022 amidst rising international prices and remained steady for services in the next two quarters, heightened geopolitical uncertainties. with softer momentum in Q2 and Q3. Unit labour The ongoing conflict in the Black Sea region and costs also moderated in Q3:2021-22 owing to the ensuing sanctions have hampered global supply sharp increase in growth in value of production of chains and have also sent prices soaring with the listed firms both in manufacturing and services Chart II.20: Wage Growth (y-o-y) and Inflation in Rural Areas (y-o-y) Sources: NSO; Labour Bureau; and RBI staff estimates. 3322Chapter II Prices and Costs Chart II.21: Labour Cost in Manufacturing and Services a: Staff Cost in Manufacturing Sector b: Staff Cost in Services Sector Note: Unit labour cost =Staff cost/value of production. The staff cost growth (y-o-y) is based on common set of companies. Sources: Capitaline database; and RBI staff estimates. vis-à-vis staff costs during Q2 and Q3:2021-22 higher fuel, raw material, chemical, retail, vegetable (Chart II.21a and b). and transportation costs. However, the pace of output prices for both manufacturing and services sectors Manufacturing firms polled for the purchasing managers’ index (PMI) reported a sustained increase so far remained modest as compared to input prices, in input prices in March 2022. Also, the PMI services reflecting restricted pass-through amidst firms’ sector reported continued increase in input prices till limited pricing power due to the prevalent slack in the March 2022 with firm momentum, mainly driven by economy (Box II.1). Box II.1: An Analysis of Sensitivity of Output Prices to Input prices Input cost prices have been rising during 2021-22, though In the Indian context, PMI price indices have significant its pass-through to output prices has remained muted in predictive power about changes in wholesale price inflation (WPI) (Khundrakpam and George, 2013) 11. view of the continuing slack in demand (Patra, 2022). The gap between input and output prices has remained wide Granger causality tests using monthly data from January during 2021-22 (Chart II.1.1). In advanced economies like 2011 to February 2022 confirm that PMI input prices do influence output prices and core CPI, a measure of the United States and the Euro area, pricing power of inflation exclusive of volatile components i.e., food and firms has increased significantly against intense pressures fuel, with no evidence of reverse causality12. To further from elevated input prices and in the presence of strong examine the strength of the relationship, ordinary least demand (Vijlder, 2022). (Contd.) 11 Studies in the US have successfully used PMI price indices, along with other variables, to forecast inflation (Banerjee and Marcellino, 2006; and Wright, 2008). 12 The null of no causality is rejected for PMI input prices to output prices and input prices to core CPI at 5 per cent level of significance. While for the former it holds from first lag to higher lags of input prices, significance reduces for higher lags for input prices to core CPI. 3333Monetary Policy Report April 2022 Chart II.1.1: Input-Output Price Gap and Table II.1.1: Empirical Results: Input to Output prices Core Inflation a. OLS: Composite PMI Input to b. ARDL: Composite PMI Output prices Input prices to Core CPI Dependent Variable: Bounds test for F-statistic 3.50* Output prices Co-integration@ Constant 31.213*** Note: “Ho: No Co-integration”; (0.00) “H1: There is long run co-integrated relationship”; Input Prices 0.233*** @: Future output as a control; (lagged) (0.00) Conventional significance based on Future Output 0.130*** F-statistics as extracted from Narayan (0.00) (2005). Dum_Apr20 -9.563*** Long run estimation (0.00) (Dependent variable: Core CPI) Adjusted 0.74 0.108*** PMI input prices R-square (0.00) Sources: IHS Markit; NSO; and RBI staff estimates. Note: ***, ** and * indicate the rejection of the null hypothesis at 1, 5 and 10 per cent levels of significance. Figures in parenthesis are p-values. The ARDL models are chosen based on automatic selection by AIC criteria. OLS model is with four lags. The results are estimated for period: April 2012-Febraury 2022. squares (OLS) and autoregressive distributed lag (ARDL) Source: RBI staff estimates. models are used depending upon the degree of integration of the variables.13 (Table II.1.1b). The long run pass-through coefficient from PMI input prices to core CPI at 0.11 is modest. Empirical analysis in an OLS framework suggests pass- through from lagged PMI composite input prices to References: corresponding output prices, after controlling for future Khundrakpam, J. K., & George, A. T., (2013), “An Empirical output14 (Table II.1.1a). The pass-through is, however, Analysis of the Relationship between WPI and PMI- less than complete, reflecting, inter alia, the role of other Manufacturing Price Indices in India”, Reserve Bank of demand side factors. India, WPS (DEPR):06 Analysis of PMI composite input prices and core Patra, M.D. (2022), “Taper 2022: Touchdown in Turbulence” CPI inflation along with PMI future output for the speech at the IMC Chamber of Commerce and Industry”, period April 2012 to February 2022 in an ARDL model March. of co-integration, which allows for use of variables of different degrees of integration, confirms the Vijlder, W., (2022), “Companies’ Pricing Power and the existence of a long run co-integrating relationship Inflation Outlook”, BNP Paribas. The salary outgo for the manufacturing, services Q3:2021-22. For manufacturing firms, the pace of and infrastructure firms polled in Reserve Bank’s increase moderated in Q4:2021-22 and expected to enterprise surveys15 reported an increase in pick up again in Q1:2022-23, but in the case of services 13 The results of unit root tests indicate that while the null hypothesis of the presence of unit root is rejected for PMI Composite input and output price series making them I(0) variables, it is not rejected for core CPI making it an I(1) variable. Accordingly, OLS is adopted for PMI input to output prices while controlling for the activity parameter, ARDL model is adopted for PMI Input prices to Core CPI. 14 The future output index of composite PMI is used as an indicator of expected demand. 15 Industrial Outlook Survey; and Services and Infrastructure Outlook Survey. 3344Chapter II Prices and Costs Chart II.22: Expectations of Cost Conditions (Net Response) a: Salary Outgo b: Cost of Inputs c: Selling Prices Note: ‘Net response’ is the difference between the percentage of respondents reporting increase in prices and those reporting decrease. Sources: Reserve Bank’s Industrial Outlook Survey; Services & Infrastructure Outlook survey; and RBI staff estimates. and infrastructure firms, it is expected to moderate in II.4 Conclusion Q1:2022-23. Input cost pressures remained elevated Recent geopolitical events have accentuated upside for manufacturing, services and infrastructure firms risks to inflation. Global supply shocks are still during Q3 and Q4:2021-22. During Q1:2022-23, unfolding and their ambit across commodities is manufacturing input costs are expected to remain widening. Input costs, including energy costs, for elevated while some moderation in pace of increase various manufacturing goods and services are also may occur for services and infrastructure firms. likely to go up. The impact of recent events will also Manufacturing firms may charge higher selling be conditioned by the outlook for aggregate demand prices in Q1:2022-23, vis-à-vis their services and going forward. Persistent commodity price pressures infrastructure sector counterparts (Chart II.22). One along with the resurgence of global supply chain and year ahead business inflation expectations16 polled logistics disruptions pose risk of their pass-through to by the Indian Institute of Management, Ahmedabad, domestic inflation. Though the pass-through so far has rose sequentially, crossing 6 per cent in February 2022. been limited due to weak demand conditions, going The businesses polled in the survey reported further forward it may need to be monitored carefully. The heightening of cost pressures, which along with weak headroom available for supply side measures remain demand conditions impacted profit margins of the critical to limit the extent of transmission of adverse sampled firms. cost conditions onto retail prices of goods and services. 16 The monthly Business Inflation Expectations Survey (BIES) of the Indian Institute of Management, Ahmedabad, polls a panel of business leaders primarily from the manufacturing sector about their inflation expectations in the short and medium term. The latest survey pertains to February 2022 round based on the responses of around 1,000 companies. 3355III. Demand and Output The recovery in aggregate demand lost some momentum in H2:2021-22 with the emergence of the Omicron variant. External demand remained buoyant. The intensification of geopolitical tensions, the surge in global oil and commodity prices to multi-year highs and intense financial market volatility pose significant downside risks to global economic activity and could have spillovers on domestic growth prospects. The recovery in aggregate demand that had resumed pre-pandemic levels, with the demand for contact- with the ebbing of the second wave of the pandemic intensive activities impacted in December lost some momentum in H2:2021-22 with the 2021-January 2022 and the informal sector and micro, emergence of the Omicron variant. Although more small and medium enterprises (MSMEs) still lagging. transmissible, the third wave turned out to be less External demand, on the other hand, remained severe and short-lived relative to the second wave buoyant, with merchandise exports clocking double- (Chart III.1). As a result, GDP in H2 is estimated to digit growth for the thirteenth month in a row in be higher by 6.8 per cent than the corresponding March 2022. On the aggregate supply side, Chart III.1: COVID Infections and Vaccination a: New Cases b: Fatalities and Recovery Rate (7-day moving average) (7-day moving average) c: Daily Vaccinations d: Cumulative Vaccination Status (7-day moving average) (month-end) Sources: Ministry of Health and Family Welfare (MoH&FW); and Our World in Data. 36Chapter III Demand and Output Table III.1: Real GDP Growth (y-o-y, per cent) Item 2020-21 2021-22 Weighted Contribution* 2020-21 2021-22 (FRE) (SAE) 2020-21 2021-22 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4# Private final consumption expenditure -6.0 7.6 -3.4 4.4 -23.7 -8.3 0.6 6.5 14.2 10.2 7.0 1.5 (1.2) (-13.0) (1.1) (7.6) (8.1) Government final consumption expenditure 3.6 4.8 0.4 0.5 13.6 -22.9 -0.3 29.0 -4.4 9.3 3.4 11.7 (8.6) (8.6) (-15.8) (3.1) (44.0) Gross fixed capital formation -10.4 14.6 -3.3 4.4 -45.3 -4.5 -0.6 10.1 62.5 14.6 2.0 1.3 (2.6) (-11.2) (9.5) (1.4) (11.5) Exports -9.2 21.1 -1.8 4.0 -25.5 -6.4 -8.6 3.7 40.4 20.5 20.9 7.8 (9.9) (4.6) (12.7) (10.5) (11.8) Imports -13.8 29.9 -3.2 6.3 -41.1 -17.9 -5.2 11.7 60.7 40.7 32.6 1.3 (11.9) (-5.3) (15.5) (25.8) (13.2) GDP at market prices -6.6 8.9 -6.6 8.9 -23.8 -6.6 0.7 2.5 20.3 8.5 5.4 4.8 (1.8) (-8.3) (1.3) (6.2) (7.4) Note: *: Component-wise contributions to growth do not add up to GDP growth because change in stocks, valuables and discrepancies are not included. Figures in parentheses are growth rates over 2019-20. FRE: First revised estimates; SAE: Second advance estimates. #: Implicit. Source: National Statistical Office (NSO). manufacturing weakened in the face of headwinds (y-o-y) in Q3:2021-22 (Table III.1 and Chart III.2a). All from persisting global supply bottlenecks and its major constituents surpassed their pre-pandemic muted discretionary consumption and investment levels, as recovery gained traction. With the fast ebbing spending domestically. In contrast, agriculture and of the third wave, the demand for contact-intensive allied activities remained buoyant on the back of a services also recovered in February-March 2022. For record kharif production and expansion in sowing the financial year 2021-22, real GDP is estimated to acreage in the rabi season relative to a year ago. have risen by 8.9 per cent, taking its level 1.8 per cent III.1 Aggregate Demand above that recorded in 2019-20. Aggregate demand, measured by real gross domestic Private consumption and government expenditure product (GDP), decelerated to 5.4 per cent year-on-year were the key drivers of aggregate demand in H2 Chart III.2: GDP Growth and its Constituents b: Weighted Contribution of the Components a: GDP Growth and Momentum to GDP Growth Notes: 1. #-Implicit growth. 2. SAAR – Seasonally adjusted annualised rate. Sources: NSO; and RBI staff estimates. 37Monetary Policy Report April 2022 (Chart III.2b). The negative contribution of net exports Chart III.3: GDP Growth - Projection to aggregate demand moderated. versus Actual GDP Projections versus Actual Outcomes The October 2021 Monetary Policy Report (MPR) had projected real GDP growth at 7.9 per cent for Q2:2021-22, 6.8 per cent for Q3 and 6.1 per cent for Q4. Actual growth in Q2 overshot the projection by 60 basis points (bps) while it undershot the projection by 140 bps in Q3 (Chart III.3). These upside and downside surprises stemmed mainly from a stronger than expected release of pent-up demand and a pick- up in investment on the back of government capex in Q2, followed by a loss of momentum in Q3. Data for Q4:2021-22 are scheduled for release by the NSO Sources: NSO; and RBI staff estimates. on May 31, 2022. III.1.1 Private Final Consumption Expenditure year, weighed down by incomplete recovery in the Private final consumption expenditure (PFCE) – the labour force participation rate, the third wave and mainstay of aggregate demand – regained some weak consumer confidence (Box III.1). The sluggish traction, but its share in overall GDP dropped to 56.6 recovery in the informal sector and among MSMEs per cent in 2021-22 from 57.3 per cent in the previous also restrained private consumption. Expanding Box III.1: Drivers of Private Consumption Income, wealth, inflation, interest rate and consumer real private consumption and income2. The short-run confidence are potential determinants of private error-correction dynamics points to the role of the consumption (Singh, 2012; Vihriälä, 2017; Wong, 2017; cyclical factors – lower interest rates and lower inflation Dossche, et. al., 2018). According to unit root tests, private support consumption demand, attesting to a role of consumption and income (real GDP) are non-stationary1. accommodative monetary policy. Going ahead, given the For the pre-pandemic period, i.e., 2004-19, quarterly data long-run relationship, consumption can be expected to indicate a long-run co-integrating relationship between recover with rising incomes. ln PFCE= – 0.707 + 1.017 ln GDP ...(1) (0.000) (0.000) (cid:507) (ln PFCE)= – 0.133(cid:507) (ln PFCE) – 0.324(cid:507) (ln PFCE) + 0.389 (cid:507)(ln GDP) – 0.283(cid:507)(ln GDP) – 0.280 (cid:507)(ln PFCED)– 0.684(cid:507)(WACR) t t-1 t-2 t t-1 t t-3 (0.088) (0.000) (0.000) (0.056 ) (0.025) (0.068) – 0.029 Dum2010Q4 – 0.036 Dum2012Q2 + 0.024Dum2013Q4 – 0.024Dum2014Q4 – 0.534 ECT (0.003) (0.000) (0.009) (0.010) (0.000) t-1 ...(2) Note: Figures in parentheses are p-values; Adjusted R2 = 0.80; Breusch-Godfrey LM test for null of no serial correlation (2 lags) (p-value) = 0.125; Breusch-Pagan Godfrey Heteroskedasticity test (p-value) = 0.158. (cid:507) represents quarter-on-quarter change in the respective variables. PFCED: PFCE deflator; WACR: weighted average call money rate, real; ECT: error correction term. (Contd.) Source: RBI staff estimates. 1 Wealth effects captured through stock market capitalisation were not found to be significant, perhaps reflecting the still limited ownership of stocks amongst households. 2 Auto regressive distributed lag (ARDL) methodology is deployed to study the relationship. ARDL(3,2) model is selected based on the Akaike Information Criterion, 38Chapter III Demand and Output References: Dossche, M., M Forsells, L Rossi, G Stoevsky (2018), Vihriälä, E. (2017), “Household Consumption in Japan- “Private Consumption and its Drivers in the Current Role of Income and Asset Developments”, IMF Working Economic Expansion”, Economic Bulletin, European Paper WP/17/23. Central Bank. Wong, M. (2017), “Revisiting the Wealth Effect on Singh, Bhupal (2012), “How Important is the Stock Market Consumption in New Zealand”, Reserve Bank of New Wealth Effect on Consumption in India?”, Empirical Zealand Analytical Note, AN2017/03. Economics, Vol. 42, pp. 915-927. vaccination coverage, and relaxation of restrictions on Urban consumption was lifted by a recuperation mobility and activity enabled a recovery in demand in domestic air passenger traffic, especially for contact-intensive services such as air travel, hotels during February-March, and a moderation in the and restaurants, recreation and culture in February- contraction of passenger vehicle sales that had been March 2022. hit by shortages in respect of semi-conductor chips (Chart III.4). Consumer durables production, on the Chart III.4: Urban Demand: High Frequency Indicators a: Passenger Vehicle Sales b: Domestic Air Passenger Traffic c: Consumer Durables d: Household Credit Sources: Directorate General of Civil Aviation (DGCA); Society of Indian Automobile Manufacturers (SIAM); NSO; and RBI. 39Monetary Policy Report April 2022 other hand, fell in Q3 and January due to subdued rate (LFPR) fell from 40.9 per cent in December to discretionary spending. 39.5 per cent in March 2022; the unemployment rate, however, dropped from 7.9 per cent to As regards rural demand, sales of two-wheelers 7.6 per cent over the same period and remained recorded y-o-y contraction during H2, indicative of lower than the levels recorded during the first and pressures on discretionary household spending and second waves (Chart III.6a). Employment conditions slow recovery in the informal sector. Tractor sales improved in Q3 and January in the organised sector were lower during November-February partly due (Chart III.6b). to protracted and heavy precipitation in some areas. Fertiliser sales also remained lower during January- III.1.2 Gross Fixed Capital Formation February, reflecting inventory de-stocking and lower Gross fixed capital formation (GFCF) expanded by imports amidst rising international prices. Consumer 14.6 per cent in 2021-22 on the back of a favourable non-durables production, on the other hand, base (-10.4 per cent in 2020-21) and its share in GDP rebounded in January 2022 (Chart III.5). rose marginally to 32.0 per cent as against 31.8 per Consumer pyramids household survey data of cent in 2019-20. In H2, however, investment activity the CMIE show that the labour force participation weakened, driven down by sluggish construction Chart III.5: Rural Demand: High Frequency Indicators a: Tractor Sales b: Motorcycle Sales c: Consumer Non-durables d: Fertiliser Sales Sources: Tractor Manufactures Association; SIAM; NSO; and Ministry of Chemicals and Fertilisers. 40Chapter III Demand and Output Chart III.6: Employment Situation in India a: Unemployment and Labour Participation Rates b: Net Payroll Additions based on EPFO Records Sources: CMIE; and Employees’ Provident Fund Organisation (EPFO). activity (reflected in steel consumption and cement and shortage of manpower (Chart III.7). The domestic production) due to unseasonal rains, rising input costs production of capital goods slipped into contraction Chart III.7: Indicators of Investment Demand a: Imports of Capital Goods b: IIP Capital Goods 140 120 100 80 60 40 20 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec c: Finished Steel Consumption d: Cement Production Sources: DGCI&S; NSO; Joint Plant Committee; and Office of Economic Adviser. 41 )001=21-1102(xednI 2019 2020 2021 2022 200 150 100 50 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec )001=21-1102(xednI 2019 2020 2021 2022Monetary Policy Report April 2022 Chart III.8: Capacity Utilisation in Manufacturing Chart III.9: Interest Coverage Ratio in Manufacturing and Services Firms Note: Data for Q3:2021-22 are based on results of 1,701 listed private manufacturing companies and 717 listed non-financial services companies. Source: RBI. Source: RBI staff estimates. in Q3:2021-22 and January 2022, weighing on overall The interest coverage ratio (ICR)3 of listed non- investment activity, even as imports of capital goods financial private companies in the manufacturing expanded during Q3 and Q4. and information technology (IT) sectors remained steady in Q3:2021-22 (Chart III.9). Stronger corporate Capacity utilisation (CU) in the manufacturing balance sheets – comfortable ICR and deleveraging – sector recovered to 72.4 per cent in Q3:2021-22 from can be expected to support capacity expansion further 68.3 per cent in the previous quarter (72.2 per cent (Box III.2). from 68.6 per cent on a seasonally adjusted basis) (Chart III.8); it reached the pre-pandemic levels, Under the production-linked incentives (PLI) scheme, although it was below the long-period average. the government approved a programme of `2.3 lakh Box III.2: Private Sector Investment Cycle Drivers: An Investigation with Firm-Level Data A revival in the investment cycle is vital for ensuring a (measured by either debt to total assets or debt to equity); durable recovery. Despite congenial financial conditions demand conditions (own sales); internal resources and and a strengthening of corporate balance sheets – funding costs (own cash flows and effective cost of moderation in listed firms’ leverage in terms of debt/asset borrowings); and size of the firm have diverse effects on and debt/equity ratios – private investment remains weak investment. Leverage exerts a negative impact on fixed in India (Chart III.2.1). investment, while demand in terms of own sales and cash Using a panel data of a common set of 1,054 listed non- flows has a positive effect (Table III.2.1). The cost of government non-financial (NGNF) companies over the borrowings dampens investment, and firm size has a past twenty half year periods (H2:2011-12 to H1:2021-22), negative impact on capacity expansion (i.e., the small- it is observed that firm-specific factors – leverage (Contd.) 3 Interest coverage ratio is the ratio of earnings before interest and taxes to interest expenses and measures a company’s capacity to make interest payments on its debt. 42Chapter III Demand and Output Chart III.2.1: Leverage and Investment Growth Table III.2.1: Panel Regression Results (Period: H1:2012-13 – H1:2021-22) Dependent Variable: All Listed NGNF Manufacturing Investment growth Companies Constant 13.458*** 16.724*** 16.388*** 21.900*** (3.506) (4.088) (4.370) (4.947) Debt to total assets -0.119*** -0.101*** t-1 (0.019) (0.023) Debt to equity -0.024*** -0.021*** t-1 (0.005) (0.006) Demand 0.006*** 0.006*** 0.008*** 0.008*** t-1 (0.001) (0.001) (0.001) (0.001) Cash flow 0.016*** 0.016*** 0.039*** 0.044*** t-1 (0.005) (0.005) (0.008) (0.009) Cost of borrowings -0.048*** -0.041*** -0.037* -0.038* t-1 (0.016) (0.016) (0.020) (0.021) Size -2.849*** -3.665*** -3.239*** -4.390*** t-1 Notes: Investment growth calculated as half-yearly annualised growth in (0.611) (0.724) (0.720) (0.829) gross fixed assets; Debt to total assets and debt to equity calculated as total Real GDP growth t-1 0.150*** 0.138*** 0.127*** 0.104*** borrowings scaled by total assets and book value of equity respectively. (0.027) (0.029) (0.032) (0.034) Expected growth 0.504*** 0.588*** 0.485*** 0.609*** Source: RBI staff estimates based on data of 1,054 listed NGNF companies t+1 (0.108) (0.115) (0.114) (0.120) from Capitaline database. WPI inflation 0.127** 0.137*** 0.075 0.093 t-1 (0.049) (0.051) (0.056) (0.058) sized firms add more to their existing capital stock Observations 18,972 17,878 12,744 12,002 Number of firms 1,054 1,038 708 697 compared with large-sized firms). Aggregate demand conditions in the economy, especially expected growth Notes: ***, ** and * indicate statistical significance at 1 per cent, 5 per cent and 10 per cent, respectively. Fixed effect estimates, with robust prospects, have a positive and statistically significant standard errors in parenthesis. Variables are defined as follows: Demand impact. is annualised sales scaled by the beginning of the period gross fixed assets; cash flow as annualised net profits plus depreciation scaled by the References: beginning of period gross fixed assets; size is log of total assets; expected growth is taken as one year ahead growth projection from the survey of Das, S., and V. Tulin (2017), “Financial Frictions, professional forecasters. Underinvestment, and Investment Composition: Evidence Sources: RBI staff estimates; and Capitaline database. from Indian Corporates”, IMF Working Paper, WP/17/134. Wang, J., M. Gochoco and N. Sotocinal (2013), “Corporate Shukla, A. K., and T. S. Shaw (2020), “Impact of Leverage Investments in Asian Emerging Markets: Financial on Firms’ Investment: Decoding the Indian Experience”, Conditions, Financial Development, and Financial RBI Working Paper, WPS 07/2020. Constraints”, ADB Economics Working Paper Series, 346. crore to position India as a global hub for electronics The gross domestic saving rate fell to 28.2 per cent manufacturing. Gati Shakti – the National Master in 2020-21 from 29.9 per cent of GDP in 2019-20, Plan for Multi-modal Connectivity – incorporates the dampened by increased dissaving of the government infrastructure schemes of various Ministries and State due to a rise in spending to ameliorate the stress of Governments such as Bharatmala, Sagarmala, inland the pandemic (Chart III.10). Net household financial waterways, dry/land ports and UDAN for integrated saving inched up to 11.6 per cent of GDP in 2020-21 planning and coordinated implementation of from 8.0 per cent in 2019-20, driven by the pandemic- infrastructure connectivity projects. The multi-modal induced forced as well as precautionary savings. With plan will help improve India’s logistics network and the investment rate declining from 30.7 per cent of competitiveness, providing integrated and seamless GDP to 27.3 per cent, the saving-investment gap turned connectivity for the movement of people, goods and positive in 2020-21 (for the first time since 2004-05), services from one mode of transport to another. mirrored in a current account surplus recorded in the 43Monetary Policy Report April 2022 Chart III.10: Saving-Investment Gap Table III.2: Central Government Finances Indicator Per cent to GDP 2019-20 2020-21 2021-22 2022-23 (RE) (BE) 1. Revenue receipts 8.4 8.3 8.8 8.5 a. Tax revenue (Net) 6.8 7.2 7.5 7.5 b. Non-Tax revenue 1.6 1.0 1.3 1.0 2. Non-debt capital receipts 0.3 0.3 0.4 0.3 3. Revenue expenditure 11.7 15.6 13.4 12.4 a. Interest payments 3.0 3.4 3.4 3.6 b. Major subsidies 1.1 3.6 1.8 1.2 4. Revenue expenditure 7.5 8.6 8.1 7.5 excluding interest payments and subsidies 5. Capital expenditure 1.7 2.2 2.5 2.9 6. Capital outlay 1.6 1.6 2.3 2.4 7. Total expenditure 13.4 17.7 15.9 15.3 8. Gross fiscal deficit 4.7 9.2 6.7 6.4 Sources: NSO and RBI staff estimates. 9. Revenue deficit 3.3 7.3 4.6 3.8 10. Primary deficit 1.6 5.7 3.3 2.8 Sources: Union Budget 2022-23 and RBI staff estimates. balance of payments. Net household financial saving (Chart III.12c). Centre's revenue and capital rate fell to 10.7 per cent in H1:2021-22 from 14.1 per expenditure rose y-o-y by 10.2 per cent and 19.7 per cent in the same period of 2020-21. cent, respectively, during April-February 2021-22. III.1.3 Government Consumption Overall, the centre’s gross tax revenues improved The pace of government final consumption from 10.2 per cent of GDP in 2020-21 to 10.6 per cent expenditure (GFCE) moderated in Q3 on a y-o-y basis due to adverse base effects. Government capital spending, on the other hand, surged in Q3, reflecting Chart III.11: Growth in Centre's Revenue Expenditure and Capital Expenditure during 2021-22 the push to infrastructure (Chart III.11). During 2021-22, the fiscal position of the Central Government strengthened (Table III.2 and Chart III.12). The centre’s net tax revenue increased by 21.8 per cent during April-February 2021-22. Corporate tax collections jumped by 61.3 per cent, supported by strong corporate performance while customs duties collections rose by 46.6 per cent on increased imports. Excise duty collections, however, rose relatively modestly by 5.4 per cent, owing to the cut in excise duty on petrol and diesel in November. GST collections surpassed `1 lakh crore mark consistently in H2, driven by the revival in #: Implicit economic activity and improved tax compliance Sources: Controller General of Accounts and Union Budget 2022-23 44Chapter III Demand and Output Chart III.12: Central Government Tax Collections: April - February a. Direct Taxes b. Indirect Taxes c: GST Collections Sources: Controller General of Accounts, Ministry of Finance. in 2021-22 (Table III.3). Higher revenues along with The central government’s revenue expenditure the containment of revenue expenditure contributed excluding interest and subsidy payments is budgeted to fiscal consolidation in 2021-22. to fall to 7.5 per cent in 2022-23 – back to the pre- pandemic position – from 8.1 per cent of GDP in Table III.3: Central Government Tax Revenues 2021-22 (Table III.2). Capital expenditure increased Indicator Per cent to GDP to 2.5 per cent in 2021-22 from 2.2 per cent of GDP 2019-20 2020-21 2021-22 2022-23 in 2020-21 and is budgeted to rise further to 2.9 (RE) (BE) per cent in 2022-23, reflecting the government’s 1. Direct tax 5.2 4.8 5.3 5.5 emphasis on public infrastructure such as road (i) Corporation 2.8 2.3 2.7 2.8 (ii) Income 2.5 2.5 2.6 2.7 transport, railways. 2. Indirect tax 4.8 5.4 5.3 5.1 (i) GST 3.0 2.8 2.9 3.0 The centre’s market borrowing programme for (ii) Customs 0.5 0.7 0.8 0.8 2021-22 remained at elevated levels for the second (iii) Excise 1.2 2.0 1.7 1.3 3. Gross tax revenue (1+2) 10.0 10.2 10.6 10.7 successive year (Table III.4). Ample surplus liquidity, 4. Net tax revenue 6.8 7.2 7.5 7.5 open market operations (OMO), including the Note: BE: Budget Estimates. RE: Revised Estimates. Source: Union Budget, 2022-23. secondary market government securities acquisition 45Monetary Policy Report April 2022 Table III.4: Centre’s Borrowings Chart III.13: Merchandise Trade (` Lakh Crore) Item 2019-20 2020-21 2021-22 2022-23 (RE) (BE) I Net borrowings (G-Sec) 4.7 10.4 7.8 11.1 Repayments 2.4 2.3 2.7 3.8 Gross borrowings (G-Sec) 7.1 12.6 10.5 14.9 II T-Bills/Cash management bills 1.5 2.0 1.0 0.5 (Net) III Net market borrowings (I+II) 6.2 12.4 8.8 11.6 IV Securities against small savings 2.4 4.8 5.9 4.3 V State provident fund 0.1 0.2 0.2 0.2 VI Other receipts 0.4 0.1 -0.9 0.4 VII External debt 0.1 0.7 0.2 0.2 VIIITotal debt (III to VII) 9.3 18.3 14.2 16.6 IX Drawdown on cash balances 0.1 -0.1 1.7 0.0 X Total funding (VIII+IX) 9.4 18.2 15.9 16.6 Sources: Government of India; and RBI staff estimates. Source: DGCI&S. programme (GSAP), facilitated the completion of the borrowing calendar in a non-disruptive manner III.1.4 External Demand at a weighted average cost of 6.28 per cent in 2021- Merchandise exports and imports remained buoyant 22 (5.79 per cent in 2020-21). The weighted average in H2:2021-22. With the expansion in imports maturity of the central government issuances was outpacing exports, the trade deficit widened in H2. further elongated to a record 16.99 years in 2021- Exports at US$ 40.4 billion touched a new record in 22 from 14.49 years during 2020-21. States’ gross March 2022 and remained above US$ 30 billion for the borrowings of `7.02 lakh crore were completed at a thirteenth consecutive month (Chart III.13). During weighted average cost of 6.97 per cent during 2021- 2021-22, merchandise exports at US$ 417.8 billion 22 (6.52 per cent in 2020-21). crossed the target of US$ 400 billion. The Union Budget 2022-23 has placed gross market Merchandise exports were driven by engineering borrowings at `14.95 lakh crore (44.2 per cent above goods, petroleum products, chemicals, gems and the previous year). Taking into account the switch jewellery, cotton textiles, and electronic goods (Chart operations conducted on January 28, 2022, the gross III.14a and b). Ready-made garments, primarily labour- market borrowings through dated securities for 2022- intensive, also contributed positively, reversing 23 are estimated at `14.31 lakh crore. In H1:2022-23, the losses observed during April-September 2021. gross market borrowings of the central government Exports from the Special Economic Zones (SEZs) through dated securities have been planned at `8.45 contribute around 30 per cent to India’s total exports. lakh crore, 59.0 per cent of the estimated gross The Union Budget 2022-23 proposal to replace the borrowing for the year. The central government has Special Economic Zone Act with new legislation is been provided ways and means advances (WMA) limit expected to further enhance SEZ exports through of `1.50 lakh crore for H1:2022-23 for bridging short- efficiency gains from more effective leveraging term mismatches between receipts and payments. of the existing infrastructure, reduction in the The WMA limit for state governments has been fixed compliance burden and integration of the SEZs and at `47,010 crore with effect from April 1, 2022. customs administration. The free trade agreement 46Chapter III Demand and Output Chart III.14: Merchandise Exports a: Exports Growth – Relative Contribution b: Major Drivers of Exports in H2 2021-22 – Relative Contribution (over pre-Covid) Sources: DGCI&S and CPB, Netherlands. (FTA) with the United Arab Emirates (UAE) – the and Trade Agreement (ECTA) with Australia provides second-largest export destination for India – will preferential access to India on 100 per cent of boost India’s labour-intensive exports such as gems Australian tariff lines and is expected to double the and jewellery, textiles, leather and footwear and bilateral trade to almost US$ 50 billion in five years. engineering goods and pharmaceuticals and enhance Merchandise imports reached an all-time high of India’s market access to the Middle East and African US$ 60.3 billion in December 2021 and remained regions. The recently signed Economic Cooperation above US$ 50 billion for the seventh consecutive Chart III.15: Merchandise Imports a: Imports Growth – Relative Contribution b: Major Drivers of Imports in H2 2021-22 – Relative Contribution (over pre-Covid) Source: DGCI&S. 47Monetary Policy Report April 2022 month in March 2022. During H2:2021-22, oil imports In the context of the recent geopolitical developments, (US$ terms) were higher by 38.5 per cent over the India’s merchandise exports to Russia and Ukraine corresponding pre-pandemic period; in volume are only 0.8 per cent and 0.1 per cent of total exports terms, however, oil imports were still below the pre- while the corresponding import shares are 1.5 per cent pandemic levels. After registering a robust growth and 0.5 per cent, respectively (Table III.5). The direct for three consecutive quarters, gold imports posted spillovers from Russia-Ukraine developments on decelerated growth in Q3:2021-22 but contracted India’s overall merchandise trade and output are thus expected to be limited although the indirect channels during Q4 as festival demand waned (Chart III.15a). – global slowdown, surge in commodity prices, risk The rise in non-oil non-gold imports during H2 was aversion and financial market volatility – could have a led by electronic goods, coal, coke and briquettes and more sizeable impact. chemicals (Chart III.15b). The trade deficit widened to US$ 118.2 billion in H2:2021-22 from US$ 76.3 billion Services sector trade recovered during 2021-22, a year ago. surpassing pre-pandemic levels (Chart III.16). Table III.5: India’s Merchandise Trade with Russia and Ukraine (US$ million) Commodities Exports Commodities Imports 2019 2020 2021 2019 2020 2021 A. Trade with Russia Drug formulations, biologicals 461 269 503 Petroleum crude 1,470 781 2,306 Telecom instruments 455 174 384 Coal, coke and briquettes 970 532 1,121 Iron and steel 106 93 193 Petroleum products 440 363 969 Marine products 100 56 130 Pearl and stones 504 316 861 Bulk drugs & intermediates 97 70 118 Fertilisers manufactured 458 458 483 Residual chemicals and allied 66 57 106 Project goods 440 318 399 Auto components 77 40 106 Gold 0 98 325 Tea 105 64 85 Vegetable oils 156 338 304 Other construction machinery 57 32 75 Other rubber products 91 56 151 Machinery for dairy 165 38 66 Silver 138 145 137 Total of top 10 1,689 894 1,765 Total of top 10 4,668 3,405 7,055 Total exports to Russia 2,977 1,835 3,331 Total imports from Russia 6,238 4,608 8,436 Share in India's total exports (%) 0.92 0.91 0.84 Share in India's total imports (%) 1.28 1.77 1.47 B. Trade with Ukraine Drug formulations, biologicals 107 93 150 Vegetable oils 1,553 1,081 1,852 Telecom instruments 35 27 25 Fertilisers manufactured 115 158 341 Iron and steel 19 9 24 Inorganic chemicals 70 63 200 Agro chemicals 8 9 19 Project goods 9 18 37 Auto tyres and tubes 7 6 16 Plywood and allied products 23 15 34 Coffee 14 8 15 Machinery for dairy 20 19 20 Ceramics and allied products 8 9 15 Plastic raw materials 71 39 18 Marine products 4 5 12 Iron and steel 69 16 15 Plastic sheet, film, etc 8 8 11 Processed minerals 16 7 15 Machinery for dairy 8 4 11 Railway transport equipment 0 0 12 Total of top 10 219 178 297 Total of top 10 1,946 1,416 2,545 Total exports to Ukraine 456 306 510 Total imports from Ukraine 2,093 1,483 2,599 Share in India's total exports (%) 0.14 0.15 0.13 Share in India's total imports (%) 0.43 0.57 0.45 Source: DGCI&S. 48Chapter III Demand and Output Chart III.16: Services Trade Chart III.17: Net Foreign Direct and Portfolio Investment Note: Data for 2021-22:Q4 are provisional. For net FDI, data relate to January 2022. Source: RBI. Sources: National Securities Depository Limited (NSDL) and RBI. Software services, constituting more than 40 per cent buyers in Q2:2021-22, turned net sellers from Q3 of India’s total services exports, exhibited a strong in view of the resurgence of COVID-19 infections, growth in 2021-22 led by banking, financial and concerns over the pace of US Fed’s monetary policy insurance services; retail and consumer business; normalisation, correction in the equity market and communication, media and technology; and healthcare geopolitical tensions. Net inflows under external segments. The migration towards cloud services commercial borrowings remained at US$ 2.5 billion and the strengthening of infrastructure specifically during H2 (October-February), around the same level to meet the pandemic-centric demand significantly as a year ago, the funds being used for on-lending/ aided the sector. The overall growth in the services sub-lending, refinancing of rupee loans, repayment exports rose to 25.6 per cent in Q3:2021-22 (the of the earlier borrowings, working capital, and new highest since Q2:2011-12) and stayed strong in Q4. projects. Accretions under non-resident deposit Inward remittances remained buoyant in Q3:2021-22. accounts moderated to US$ 1.0 billion during H2 (October-January) from US$ 3.1 billion a year ago. As Notwithstanding the resilience in the services exports on March 31, 2022, India’s foreign exchange reserves and remittances, the current account deficit rose to stood at US$ 607.3 billion, equivalent to 12 months of 2.7 per cent of GDP in Q3 from 1.3 per cent in Q2 merchandise imports in 2021-22 or 98.8 per cent of mirroring the widening merchandise trade deficit. outstanding external debt at end-December 2021. Turning to the financial account, capital flows III.2 Aggregate Supply moderated during H2:2021-22 (Chart III.17). Net FDI flows fell to US$ 11.0 billion in H2:2021-22 (October- Growth in gross value added (GVA) moderated to January) from US$ 18.9 billion a year ago on the 4.4 per cent in H2:2021-22 from 13.0 per cent in H1. back of higher outward FDI flows and repatriations Overall, GVA expanded by 8.3 per cent in 2021-22 and by FDI companies. Foreign portfolio investors, net exceeded its 2019-20 level by 3.1 per cent (Table III.6). 49Monetary Policy Report April 2022 Table III.6: Real GVA Growth (y-o-y, per cent) Sector 2020-21 2021-22 Weighted 2020-21 2021-22 (FRE) (SAE) Contribution 2020-21 2021-22 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4# Agriculture, forestry and fishing 3.3 3.3 0.5 0.5 3.0 3.2 4.1 2.8 3.5 3.7 2.6 3.5 (6.7) (6.6) (7.0) (6.8) (6.5) Industry -1.8 10.4 -0.4 2.3 -28.1 3.0 6.2 11.6 40.4 6.6 1.4 3.0 (8.4) (0.9) (9.8) (7.6) (15.0) Mining and quarrying -8.6 12.6 -0.2 0.3 -17.8 -7.9 -5.3 -3.9 17.6 14.2 8.8 10.7 (2.9) (-3.3) (5.2) (3.1) (6.4) Manufacturing -0.6 10.5 -0.1 1.9 -31.5 5.2 8.4 15.2 49.0 5.6 0.2 1.7 (9.8) (2.1) (11.0) (8.6) (17.2) Electricity, gas, water supply and other utilities -3.6 7.8 -0.1 0.2 -14.8 -3.2 1.5 3.2 13.8 8.5 3.7 5.4 (3.9) (-3.0) (5.0) (5.2) (8.8) Services -7.8 8.8 -4.9 5.4 -24.3 -10.4 0.0 4.3 15.5 10.0 6.7 4.7 (0.4) (-12.5) (-1.4) (6.7) (9.2) Construction -7.3 10.0 -0.6 0.8 -49.4 -6.6 6.6 18.3 71.4 8.2 -2.8 -2.6 (1.9) (-13.2) (1.0) (3.6) (15.2) Trade, hotels, transport, communication -20.2 11.6 -4.1 2.0 -49.9 -18.8 -10.1 -3.4 34.3 9.5 6.1 7.2 (-10.9) (-32.8) (-11.1) (-4.6) (3.6) Financial, real estate and professional services 2.2 4.3 0.5 1.0 -1.1 -5.2 10.3 8.8 2.3 6.2 4.6 4.2 (6.6) (1.2) (0.6) (15.3) (13.3) Public administration, defence and other services -5.5 12.5 -0.7 1.6 -11.4 -10.2 -2.9 1.7 6.3 19.5 16.8 7.1 (6.4) (-5.8) (7.4) (13.4) (8.9) GVA at basic prices -4.8 8.3 -4.8 8.3 -21.4 -5.9 2.1 5.7 18.4 8.4 4.7 4.1 (3.1) (-7.0) (2.0) (6.9) (10.1) Note: FRE: First revised estimates; SAE: Second advance estimates. Figures in parentheses are growth rates over 2019-20. #: Implicit. Source: NSO. III.2.1 Agriculture Table III.7: Agricultural Production in 2021-22 (Second Advance Estimates) GVA in agriculture and allied activities expanded by (Lakh tonnes) 3.0 per cent in H2, supported by adequate and well- Crop 2020-21 2021-22 Variation in 2021-22 spread southwest and northeast monsoon rains, good (Per cent) reservoir levels and improved soil moisture, which SAE Final Target SAE Over Over Over SAE Final Target helped rabi acreage to increase by 1.5 per cent over the 2020-21 2020-21 previous year. Foodgrains production touched a new Foodgrains 3033.4 3107.4 3107.4 3160.6 4.2 1.7 1.7 record in 2021-22 with both kharif and rabi output Kharif 1479.5 1505.8 1505.8 1535.4 3.8 2.0 2.0 Rabi 1554.0 1601.7 1601.7 1625.3 4.6 1.5 1.5 exceeding the final estimates for 2020-21 as well as the Rice 1203.2 1243.7 1211.0 1279.3 6.3 2.9 5.6 targets (Table III.7). The production of pulses in 2021- Wheat 1092.4 1095.1 1100.0 1113.2 1.9 1.7 1.2 22 rose by 5.9 per cent, while oilseeds and sugarcane Pulses 244.2 254.6 254.6 269.6 10.4 5.9 5.9 Oilseeds 373.1 359.5 384.0 371.5 -0.4 3.3 -3.3 production achieved record levels. Sugarcane 3976.6 4054.0 3970.0 4140.4 4.1 2.1 4.3 Cotton # 365.4 352.5 370.0 340.6 -6.8 -3.4 -7.9 Horticulture production fell by 0.4 per cent to 3,332.5 Jute & 97.8 93.5 106.0 95.7 -2.1 2.3 -9.7 lakh tonnes during 2021-22 due to lower output of Mesta ## #: Lakh bales of 170 kgs. each. tomato, other vegetables, spices, flowers, aromatics ##: Lakh bales of 180 kgs. each. and medicinal plants; the output of total fruits and SAE: Second advance estimates. Source: Ministry of Agriculture and Farmers’ Welfare, Government of onion production, on the other hand, rose. India. 50Chapter III Demand and Output As on March 31, 2022, the overall procurement Chart III.18: Contribution of Crops and of rice touched 503.42 lakh tonnes which is 8.2 per Allied Activities cent higher than a year ago. Buffer stocks remained above the norms – 571.6 lakh tonnes for rice (7.5 times the norm) and 212.7 lakh tonnes for wheat (1.5 times the norm) at mid-March 2022, notwithstanding the offtake of 365.7 lakh tonnes of cereals (April- February 2021) for COVID-19 relief (mainly the Pradhan Mantri Garib Kalyan Anna Yojana, PM-GKAY) (Chart III.19). High-frequency indicators of the rural economy suggest a mixed picture during H2 (Table III.8). Agriculture and allied exports and agriculture credit registered robust growth in H2. Demand for jobs under the Mahatma Gandhi National Rural Sources: NSO; and RBI staff estimates. Employment Guarantee Scheme (MGNREGS) was lower than a year ago due to higher rabi sowing, Allied activities – livestock, forestry and fishing although it was still above pre-pandemic levels. Sales – impart substantial resilience to the agricultural of tractors, fertilisers and two-wheelers remained sector as a whole. Though allied activities have a lower than in the previous year. share of around 45 per cent in the overall GVA of the sector, their contribution to growth in aggregate The agricultural sector will benefit from measures agricultural GVA for 2020-21 was higher at 68 per cent announced in the Union Budget 2022-23 which (Chart III.18). include strengthening public and private investment Chart III.19: Stock, Procurement and Offtake – Wheat and Rice a: Wheat b: Rice Source: Food Corporation of India, GoI. 51Monetary Policy Report April 2022 Table III.8: Rural Economy - High Frequency Indicators Item Unit H1 (Apr-Sep) H2 (Oct-Feb) 2019-20 2020-21 2021-22 2019-20 2020-21 2021-22 Tractor sales Number (in lakh) 3.6 4.0 4.4 3.2 4.1 3.3 Two-wheeler sales Number (in lakh) 97.0 59.9 65.2 68.5 76.4 57.6 Fertiliser sales Lakh tonnes 256.8 294.2 257.9 254.6 268.9 232.0 Demand for employment (MGNREGA) Crore households 11.9 17.6 16.7 8.6 12.9 11.2 Agriculture and allied sector exports USD billion 17.1 17.9 22.7 15.1 18.5 22.2 Agriculture credit growth y-o-y 7.4 6.2 9.9 10.6 8.6 10.4 Rice stock to buffer norm Ratio 2.0 1.8 2.6 6.6 6.7 7.8 Wheat stock to buffer norm Ratio 1.4 1.6 1.7 2 2.1 1.7 Sources: Tractor Manufactures Association; SIAM; Ministry of Chemicals and Fertilisers; Ministry of Rural Development; CMIE; RBI; and Food Corporation of India. in agriculture, research and education, promotion of III.2.2 Industry domestic oilseed production, use of Kisan drones, Industrial activity lost momentum in H2, as delivery of digital and high-tech agriculture services. manufacturing was affected by supply side shortages The Ken-Betwa River Linking Project with an outlay and input cost pressures (Chart III.20). Mining activity of `44,605 crore aims to bring 9.1 lakh hectare was supported by coal and natural gas, offsetting the area under irrigation. Under the PM Gati Shakti contraction in crude oil production. plan, transport and infrastructure facilities will be expanded/upgraded to revamp agri-supply chain Industrial production (IIP) growth decelerated to efficiency. 2.1 per cent in Q3 from 9.5 per cent in Q2, as the Chart III.20: Weighted Contribution to Industrial GVA Growth #: Implicit. Sources: NSO and RBI staff estimates. 52Chapter III Demand and Output Chart III.21: Index of Industrial Production (IIP) a: Sectoral Contribution to IIP Growth (y-o-y) b: Sectoral Contribution to IIP Growth over 2019 c: Use-based Contribution to IIP Growth (y-o-y) d: Use-based Contribution to IIP Growth over 2019 Sources: NSO; and RBI staff estimates. production of electrical and machinery equipment, per cent and 6.0 per cent, respectively, in Q3 (Chart chemical products, and transport equipment declined III.22a). The thermal generation was hindered for a in Q3. On the other hand, petroleum products, short period due to coal supply bottlenecks owing to electronic products, metals, and textiles output unseasonal rains impacting domestic coal production expanded. In terms of the use-based classification, and dispatches on the one hand and higher import capital goods and consumer durables contracted in prices of coal sharply curtailing imports on the other Q3, while primary goods, infrastructure goods, and (Chart III.22b). In Q4, electricity generation growth intermediate goods rose, albeit at a decelerating pace. improved to 4.0 per cent (Chart III.22c). In Q4, IIP rose by 1.3 per cent in January 2022, but capital goods and consumer durables remained in Robust corporate profits supported the manufacturing contraction territory (Chart III.21). sector’s GVA in Q3 (Chart III.23). According to the Reserve Bank’s industrial outlook survey, business Electricity generation edged up by 2.4 per cent in Q3 over the corresponding period of the previous year and expectations index suggest expansion in 2022-23:Q1, 7.6 per cent over its 2019-20 level. Electricity generation although at a slower pace than in the previous survey from thermal and renewable sources increased by 1.0 round. The manufacturing purchasing managers’ 53Monetary Policy Report April 2022 Chart III.22: Electricity Generation and Consumption a: Electricity Generation and Demand Growth b: Number of Thermal Plants with Critical Coal Stock* (end-month position) c: Electricty Consumption: Region-wise *Critical coal stock is defined in terms of 6 days of stock till November 2021 and subsequently, in terms of less than 25 per cent of the normative stock. Sources: Central Electricity Authority and Power System Operation Corporation Limited (POSOCO). index (PMI) remained in expansion zone, although reflecting lower increase in output and new export moderated to 54.0 in March from 54.9 in February orders (Chart III.24a). Chart III.23: Manufacturing Sector's Profitability Note: Data for Q3:2021-22 are based on results of 1,701 listed private manufacturing companies. Source: RBI staff estimates based on data published by listed companies. 54Chapter III Demand and Output Chart III.24: PMI Manufacturing and Services a: PMI Manufacturing b: PMI Services Note: >50: Expansion, < 50: Contraction. Source: S & P Global. While overall manufacturing activity in H2 remained due to the persistence of supply shortages as well as above 2019-20 levels, the production of two-wheelers subdued demand (Table III.9). and passenger vehicles trailed pre-pandemic levels Table III.9: Industrial Sector: Progress towards Normalisation (Ratio to the respective month/quarter of 2019-2020) Indicators 2020-21 2021-22 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Jan Feb Mar I Industrial Production PMI: Manufacturing (>50 indicates growth over previous month) 35.1 51.6 57.2 56.9 51.5 53.8 56.3 54.0 54.9 54.0 II Index of Industrial Production 64 94 102 106 93 103 104 101 IIP: Manufacturing 60 94 102 107 91 102 103 100 IIP: Capital goods 35 87 99 109 74 102 97 90 IIP: Infrastructure & construction goods 53 98 105 110 98 110 109 108 IIP: Consumer durables goods 32 90 107 118 72 99 103 97 IIP: Consumer non-durables goods 83 100 103 105 98 101 103 97 IIIEight Core Industries Index 76 95 100 103 96 104 105 105 102 ECI: Steel 51 100 103 113 97 108 105 112 108 ECI: Cement 62 89 96 110 97 110 104 108 105 Electricity demand 84 99 106 108 98 108 110 106 104 IV Production of Automobiles Passenger vehicles 16 93 116 117 83 94 98 93 103 Two wheelers 21 95 118 129 60 89 91 91 90 Three wheelers 23 45 66 84 61 60 67 65 77 Production of tractors 60 123 162 167 133 142 118 106 89 Sources: CMIE; CEIC; NSO; SIAM; and RBI staff estimates. (cid:197) Below pre-Covid level Normalisation / recovery of activity (cid:198) 55Monetary Policy Report April 2022 III.2.3 Services Chart III.25: Service Sector Components Services sector activity grew by 5.7 per cent in H2 and crossed its pre-pandemic level (8.0 per cent over 2019-20). The contact-intensive services, viz., trade, hotels, transport, and communication inched towards normalisation, though their rebound was held back by the Omicron variant. Construction activity contracted in H2 due to unseasonal rains in Q3 (Chart III.25). Among its proximate indicators, finished steel consumption contracted in Q3 as well as Q4, while cement production rose in December-February after a temporary setback in November (Chart III.7c and d). Collections under the goods and services tax (GST) Note: #: Implicit. Source: NSO. and issuance of E-way bills in Q4 point towards further normalisation of domestic trading activity (Table III.10). After a rebound in Q3, domestic air traffic variant; however, it picked up again from February as moderated in January due to the spread of the Omicron infections receded. Commercial vehicle sales remained Table III.10: Services Sector: Progress towards Normalisation (Ratio to the respective month/quarter of 2019-2020) Indicators 2020-21 2021-22 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Jan Feb Mar PMI: Services (>50 indicates growth over previous month) 17.2 41.9 53.4 54.2 47.2 52.4 57.3 51.5 51.8 53.6 I Construction Steel consumption 49 93 114 122 98 92 107 110 108 159 Cement production 62 89 96 110 97 110 104 108 105 II Trade, hotels, transport, communication and services related to broadcasting Commercial vehicle sales 15 80 99 143 51 99 100 Domestic air passenger traffic 7 25 50 72 31 53 81 52 63 Domestic air cargo 26 68 90 105 78 86 93 93 81 International air cargo 43 77 87 101 94 96 100 88 90 Freight traffic 79 105 111 113 110 118 119 117 112 Port cargo 80 91 102 106 102 97 104 103 102 113 Toll collection: volume 184 349 295 174 548 699 513 248 221 Petroleum consumption 74 88 101 100 86 94 97 95 97 GST E-way bill 54 100 115 128 107 127 128 121 121 GST revenue 59 92 108 114 107 118 130 127 126 146 IIIFinancial, real estate and professional services Bank credit y-o-y growth (per cent) 5.6 5.1 6.2 5.6 5.9 6.7 9.3 8.2 8.9 9.6 Bank deposits y-o-y growth (per cent) 9.6 10.5 10.8 11.4 10.3 9.4 10.3 8.3 8.6 8.9 Life insurance first year premium 81 116 97 135 87 122 107 106 148 Non-life insurance premium 95 106 105 114 108 118 113 123 120 Sources: CMIE; CEIC; NSO; MOSPI; IRDAI; RBI staff estimates. Note: In this MPR, bank credit growth and related variations/ratios for all fortnights since December 3, 2021 are adjusted for past reporting errors by select scheduled commercial banks (SCBs). (cid:197) Below pre-Covid level Normalisation / recovery of activity (cid:198) 56Chapter III Demand and Output in expansion in Q3 and crossed pre-pandemic levels, Chart III.26: Nominal Sales Growth in Industrial while other indicators of transportation services – toll and Services Sectors collections and rail freight traffic – grew robustly in Q3 and Q4. Communication services also performed well in Q3, driven by pandemic-induced digitisation. The services PMI rose sharply to 53.6 in March from 51.8 in the preceding month on improving demand conditions and relaxation of COVID-19 restrictions (Chart III.24b). The PMI composite output index also improved to 54.3 in March from 53.5 in February. The IT sector exhibited steady growth in Q3, supported by sustained domestic and international demand, as noted earlier. Non-IT services also recorded robust growth in sales, with the gradual pick-up in contact- Note: Data for Q3:2021-22 are based on results of 1,701 listed private manufacturing companies and 717 listed non-financial services companies. intensive services (Chart III.26). Source: RBI staff estimates. Real estate activity improved in Q3, with higher new launches and sales on the back of low mortgage rates maintained robust expansion in H2. Amidst subdued and improving affordability; the inventory overhang growth in central government revenue expenditure, also declined, albeit marginally (Chart III.27a). private services appear to have been the main driver of Housing prices inched up in Q3:2021-22, led by Kochi, PADO in Q3. Centre’s revenue expenditure excluding Ahmedabad, Jaipur and Mumbai (Chart III.27b). Public interest payments and subsidies rose by 44.2 per cent administration, defence and other services (PADO) (y-o-y) during January-February. Chart III.27: Housing Sector – Launches, Sales and Prices a: Housing Activity in India b: Housing Price Index of RBI Sources: PropTiger and RBI. 57Monetary Policy Report April 2022 III.3 Conclusion conflict and the concomitant surge in global oil and commodity prices to multi-year highs amidst The thrust of the government on capital expenditure high financial market volatility pose significant and infrastructure development, and manufacturing downside risks to global economic activity and could activities through the PLI scheme should give an impetus to private investment activity, which have spillovers on domestic growth prospects. The would also benefit from the improving capacity uncertainty associated with the pace of monetary utilisation, stronger corporate balance sheets and policy normalisation in the major advanced conducive financial conditions. The intensification economies and the future course of the pandemic of geopolitical tensions following the Russia-Ukraine would also weigh on domestic industry. 58IV. Financial Markets and Liquidity Conditions During H2:2021-22, domestic financial markets remained relatively stable amidst surplus liquidity conditions with intermittent bouts of volatility caused by several factors such as Omicron’s outbreak, faster pace of monetary policy normalisation in advanced countries, domestic inflation, government borrowing programme, geopolitical conflict and the sympathetic jump in crude oil prices. Going forward, the RBI’s market operations will contextually factor in the developments in global markets to insulate domestic financial markets from spillovers. Introduction outbreak, faster than anticipated pace of normalisation in advanced countries, domestic inflation concerns, Since the October 2021 MPR, global financial markets bearishness about the large government borrowing experienced dramatic swings from buoyancy in the programme and, more recently, geopolitical conflict first half of Q3 (October-December 2021) to a whirlpool and the sympathetic jump in crude oil prices. Amidst of volatility amidst heightened uncertainties over portfolio outflows in Q4:2021-22, a pick-up in the Omicron variant and imminent tapering of asset government spending has kept short-term liquidity purchases and rate hikes by the US Federal Reserve conditions comfortable. (Fed) and other leading central banks. During Q4, the sharp escalation of geopolitical tensions in late IV.1.1 Money Market February culminating in military intervention in During H2:2021-22, money market rates firmed up Ukraine stunned global markets across asset classes. in closer alignment with the reverse repo rate – the Global oil and commodity prices spiked to multi- lower bound of the policy rate corridor – reflecting the year highs, equity markets in a number of advanced rebalancing of surplus liquidity from the overnight economies (AEs) and emerging market economies fixed rate reverse repo window towards the variable (EMEs) experienced sharp declines, sovereign bond rate reverse repo (VRRR) auctions of varying maturities yields in major AEs fell with flights to safety – partly (Chart IV.1). As a result, the weighted average call rate reversing the earlier hardening over inflation and (WACR) – the operating target of monetary policy – monetary tightening concerns – and the US dollar traded 2 basis points (bps) below the reverse repo strengthened on safe haven demand while EME rate, on average, in H2 as compared with 17 bps currencies weakened. As the Fed commenced raising below in H1. The WACR sporadically firmed up above rates in March along with guidance for quantitative the reverse repo rate due to transient factors such as tightening beginning May, the US dollar softened on the occurrence of public holidays towards the end of profit taking, bond yields firmed up, equities traded the reserve maintenance cycle in the third week of higher and commodity prices, especially oil, witnessed November 2021, advance tax payments in the second correction. Overall, global financial markets remained half of December 2021 and March 2022, and larger volatile in Q4 and shadowed by turbulence. than anticipated collections under the goods and IV.1 Domestic Financial Markets services tax (GST). Domestic financial markets remained relatively stable In the overnight call money segment, the weighted in H2:2021-22 amidst surplus liquidity conditions with average rate (WAR) of traded deals was 16 bps intermittent bouts of volatility caused by Omicron’s above the reverse repo rate while that on reported 59Monetary Policy Report April 2022 lakh crore (Chart IV.2b) which, along with lower Chart IV.1: Liquidity, Policy Corridor and WACR rates in the reported deals, pulled down the WACR below the reverse repo rate. The greater share of the reported deals in the total volume of the call money market reflected the increased share of lending by co- operative banks (85 per cent in March 2022 as against 80 per cent in September 2021). The share of the uncollateralised call money market in the total overnight money market volume at 2.0 per cent in H2 was the same as in H1. In the collateralised segment, the share of tri-party repo increased to 76 per cent in H2 from 73 per cent in H1, with a corresponding decline in the market repo share to 22 per cent from 25 per cent (Chart IV.3). Mutual funds – Source: Reserve Bank of India (RBI). the major lender in both the collateralised segments – increased their participation from 68 per cent in H1 to deals1 was 16 bps below, reflecting market 72 per cent in H2 in the tri-party repo segment; their segmentation as small cooperative banks – principal lenders in reported deals – lend at lower rates towards share in the market repo, however, declined from 70 the close of market hours (Chart IV.2a). The average per cent in H1 to 56 per cent in H2. On the borrowing monthly volume of reported deals in H2 at `1.06 lakh side, the share of public sector banks (PSBs) in the tri- crore exceeded that in the traded segment of `0.74 party repo segment increased from 52 per cent in H1 Chart IV.2: Traded and Reported Deals in the Call Money Market – Volume and Rate a: Rate b: Monthly Volume Sources: Clearing Corporation of India Ltd. (CCIL) and RBI. 1 ‘Traded deals’ are negotiated directly on the NDS-Call platform whereas ‘reported deals’ are over-the-counter (OTC) deals which are reported on the NDS-Call platform after the completion of negotiation of deals. 60Chapter IV Financial Markets and Liquidity Conditions Chart IV.3: Share in Overnight Table IV.1: Correlation of Money Market Rates Money Market Volumes with the ERRR Overnight Rates Short-term Rates (3-month) WACR Tri- Market T-bill CDs CPs party Repo (NBFC) Repo Correlation Coefficient 0.51 0.61 0.61 0.77 0.67 0.86 p-value (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Note: Based on daily data for August 13, 2021 to March 31, 2022. Source: RBI staff estimates. increased from 3.39 per cent in September 2021 to 3.78 per cent in March 2022, inching closer to the repo rate (Table IV.1). The overnight segment rates – the weighted average call rate (WACR), the tri-party repo rate and the market repo – which traded below Sources: CCIL and RBI. the reverse repo rate during H1:2021-22 – gradually trended upwards. Similarly, the rates on 3-month to 64 per cent in H2 and from 8 per cent to 16 per cent T-bill, certificates of deposit (CDs) and commercial in market repo, driven by low-cost funds from mutual paper issuances by non-banking financial companies funds. (CP-NBFCs) moved higher, with their spreads at With increasing amounts absorbed under the 26 bps, 38 bps and 80 bps, respectively, above the VRRR auctions at higher cut-offs (see section IV.3 reverse repo rate during H2 as against 1 bps, 8 bps for details), the effective reverse repo rate (ERRR)2 and 28 bps during H1 (Chart IV.4). Chart IV.4: Effective Reverse Repo and Money Market Rates Sources: RBI, Bloomberg and RBI staff estimates. 2 The effective reverse repo rate is the weighted average of the fixed rate reverse repo rate and the VRRR auctions of varying maturities with the weights being the amounts absorbed under the respective windows. 61Monetary Policy Report April 2022 Chart IV.5: Primary Issuances of Commercial Paper a: Systemic Liquidity, Issuances and WADR b: Institutional Break-up Source: RBI; CCIL-F-TRAC; and RBI staff estimates. Issuances of CDs increased to `1.73 lakh crore in H2 2021, reflecting higher issuances of short tenors from `0.60 lakh crore in H1, reflecting additional fund (Table IV.2). mobilisation by banks alongside an uptick in bank IV.1.2 Government Securities (G-sec) Market credit. Commercial paper (CP) issuances remained at `10.1 lakh crore during H2, unchanged from H1, During H2:2021-22, the 10-year G-sec yield hardened supported by ample surplus liquidity and congenial by 63 basis points, reflecting global and domestic financing conditions (Chart IV.5.a). Short-term CP factors (Chart IV.6). It rose by 24 bps during Q3, issuances were boosted by the rush of initial public driven by higher international crude oil prices, offerings (IPOs) and their financing by non-banking domestic inflation and increasing government bond financial companies (NBFCs) (Chart IV.5.b). Monthly yields in major economies including the US, which CP issuances and weighted average discount rate more than offset the intermittent softening owing (WADR) peaked in mid-November 2021, tracking IPO to the lower-than-expected CPI print for India for issuances. September, tax cuts on petrol and diesel, and a sharp decline in US yields following the outbreak of the Outstanding CPs moderated to `3.52 lakh crore in Omicron variant of COVID-19. In Q4, the benchmark March 2022 from `3.71 lakh crore in September yield firmed up by a further 39 bps owing to higher-than-expected indicative calendar of market Table IV.2: Maturity Profile of CP Issuances (` lakh crore) borrowings of State Governments/Union Territories, Tenor Mar-21 Sep-21 Dec-21 Mar-22 planned market borrowings by the Centre indicated 7- 30 days 1.08 0.32 1.53 0.15 in the Union Budget 2022-23 and the rise in US 31-90 days 0.66 0.54 0.56 0.42 yields, international crude oil and other commodity 91-180 days 0.31 0.36 0.24 0.39 181-365 days 0.18 0.12 0.15 0.19 prices over escalating geopolitical tensions. The Total@ 2.24 1.34 2.48 1.16 cancellation of two consecutive central government Outstanding 3.64 3.71 3.50 3.52 bond auctions, however, tempered the hardening of @: Total issuances during the month. Source: CCIL, F-Trac and RBI. domestic yields. 62Chapter IV Financial Markets and Liquidity Conditions Chart IV.6: 10-year Yield and Liquidity Conditions Higher indicative Higher SDL Lower CPI Omicron led sharp calendar of state auction cut-offs Cancellation of auctions decline in US yields market borrowings Excise duty cut on petrol and diesel Sources: RBI and Financial Benchmarks India Pvt. Ltd. (FBIL). At the shorter end of the primary market segment, The average level of yield increased by 38 bps during yields on T-bills firmed up in sync with the increase H2. The slope flattened by 41 bps in view of the in the effective reverse repo rate (Chart IV.7). sharper increase in the short-term rates on account of the liquidity rebalancing (Chart IV.9)3. Average trading volume in both G-secs and T-bills dipped in H2:2021-22, amidst rising yields and To facilitate debt consolidation, the Reserve Bank elevated uncertainty (Chart IV.8). conducted five switch operations on behalf of the Chart IV.7: FBIL -T-Bill Benchmark (Yield to Maturity) Source: FBIL. 3 While the level is the average of zero coupon yields of all tenors up to 30-years published by FIBIL, the slope (term spread) is the difference in zero coupon yields of 3-months and 30-year maturities. 63Monetary Policy Report April 2022 Chart IV.8: Trading Volumes and Yield a: G-Sec b: T-Bills Sources: CCIL and RBI staff estimates. central government amounting to `1.7 lakh crore The weighted average spread of cut-off yields on during H2:2021-22. The weighted average maturity state development loans (SDLs) over G-sec yields of (WAM) of the outstanding stock of G-secs increased to comparable maturities moderated to 36 bps in H2 11.71 years as on March 31, 2022 from 11.57 years as from 48 bps in H1 (Chart IV.10). The average inter-state at end-September 2021. The weighted average coupon spread on securities of 10-year tenor (fresh issuances) (WAC) at 7.11 per cent was lower than 7.15 per cent was 4 bps in H2, the same as in H1. over the same period. Chart IV.9: G-Sec Yield Curve a: Shifts b: Changes in Level and Slope Sources: FBIL and RBI staff estimates. 64Chapter IV Financial Markets and Liquidity Conditions Chart IV.10 SDLs - Amount Raised and Spread Table IV.3: Financial Markets - Rates and Spread Interest Rates Spread (bps) Instrument (per cent) (over corresponding risk-free rate) Sep Mar Variation Sep Mar Variation 2021 2022 (in bps) 2021 2022 (in bps) 1 2 3 (4 = 3-2) 5 6 (7 = 6-5) Corporate Bonds (i) AAA (1-yr) 4.17 5.04 87 35 29 -6 (ii) AAA (3-yr) 5.24 5.88 64 40 26 -14 (iii) AAA (5-yr) 5.88 6.43 55 4 0 -4 (iv) AA (3-yr) 6.07 6.59 52 124 97 -27 (v) BBB-minus (3-yr) 9.99 10.25 26 516 464 -52 10-yr G-sec 6.18 6.82 64 Note: Yields and spreads are computed as monthly averages. Source: FIMMDA and Bloomberg. and banks by 64 bps and 51 bps to 5.88 per cent and Sources: RBI and staff estimates. 5.84 per cent, respectively (Chart IV.11a). The risk premium or spread over 3-year G-sec yields declined IV.1.3 Corporate Bond Market from 49 bps to 37 bps in H2 for NBFCs, from 50 bps to 23 bps for PSUs, FIs and banks and from 40 bps to 26 Tracking G-sec yields, corporate bond yields moved bps for corporates (Chart IV.11b). higher and risk premia compressed amidst moderation in new issuances. The yields on AAA-rated 3-year The moderation in the risk premia (spreads) was seen bonds issued by NBFCs increased by 66 bps to 5.98 across tenors and rating spectrum in H2 (Table IV.3). per cent in H2 and those on corporates and public The 3-year credit default swap (CDS) spreads for the sector undertakings (PSUs), financial institutions (FIs) State Bank of India and ICICI Bank trading overseas Chart IV.11: AAA-rated 3-Year Corporate Bond Yields and Spreads a: Yields b: Spreads Source: Fixed Income Money Market and Derivatives Association of India (FIMMDA). 65Monetary Policy Report April 2022 Chart IV.12: Corporate Bond Market Activity a: Primary Market Issuances b: Overseas Issuances c: Secondary Market Turnover - Daily Average Sources: Securities and Exchange Board of India (SEBI), and Prime Database. increased by 2 bps and 10 bps, respectively at end- the approved limits from 22.3 per cent to 19.9 per cent. March 2022 from end-September 2021. The daily average secondary market trading volume increased by 10.6 per cent to `6,730 crore during H2 Issuances of corporate bonds in the primary market (up to February 2022) over the corresponding period of declined to `2.47 lakh crore during H2 (up to February 2022) from `3.06 lakh crore during the corresponding the previous year (Chart IV.12c). period of 2020-21 as corporates’ resource requirements IV.1.4 Equity Market moderated with the capex cycle being still at a nascent Indian equity markets corrected marginally in H2:2021- stage (Chart IV.12a). Corporates resorted to increased 22 amidst high volatility triggered by the outbreak of overseas issuances in 2021-22, taking advantage of the Omicron variant of COVID-19, hawkish monetary lower cost of funds abroad (Chart IV.12b). Competitive policy stances of global central banks, elevated crude oil lending rates offered by banks also contributed to lower prices and escalating geopolitical tensions. Domestic domestic bond issuances. Nearly the entire resource equities witnessed sharp selloffs in the second half mobilisation in the corporate bond market (98.2 per cent) was through the private placement route. The of February and early March 2022 over Ukraine-Russia outstanding investments by foreign portfolio investors tensions but recovered in the second half of March. (FPIs) in corporate bonds declined marginally from Overall, the BSE Sensex lost 0.9 per cent in H2 to close `1.28 lakh crore at end-September 2021 to `1.21 lakh at 58,569 (Chart IV.13a). The correction in the stock crore at end-March 2022, pulling down the utilisation of prices, coupled with higher corporate earnings, led to 66Chapter IV Financial Markets and Liquidity Conditions Chart IV.13: Stock Market Performance and Institutional Investments a: BSE Sensex and Dow Jones Industrial Average b: PE Ratio of BSE Sensex and Premium over Long Term Average c: Net Investment in Equity by Institutional Investors d: Holdings of Retail and High Net Worth Individuals in NSE-Listed Companies Sources: Bloomberg; NSDL; Prime Database; SEBI and RBI staff estimates. the price-to-earnings ratio (of BSE Sensex) falling to high net worth individuals) in equities rose further 25.1 at end-March 2022 from 27.6 at end-September during H2, extending the buying interest noted in H1 2021, moderating the valuation premium over its (Chart IV.13d). long-term average (Chart IV.13b). The vibrancy in the IPO segment continued during Apprehensions over the faster than anticipated pace H2 (up to February 2022), with 27 issuances of normalisation by the US Fed, the rise in the US mobilising `0.62 lakh crore (`0.23 lakh crore in treasury yields and the rush to safe haven amidst the corresponding period of the previous year) escalating tensions around Russia-Ukraine triggered (Chart IV.14a). The amounts raised through the a selling spree by the FPIs amounting to `1.38 lakh rights issues also increased to `0.25 lakh crore in crore from the domestic equity market in H2. These H2 (up to February) from `0.04 lakh crore during sales, however, were more than offset by purchases the corresponding period of the previous year. A by domestic institutional investors (DIIs) to the large chunk (nearly two-third) of the amount raised tune of `1.64 lakh crore (Chart IV.13c). Amongst in the IPOs was through the offer for sale (OFS) domestic buyers, retail participation (including route while around five per cent and three per cent 67Monetary Policy Report April 2022 Chart IV.14: IPO Issuances and Planned Utilisation a: Mainboard Initial Public Offers (Equity) b: Planned Utilisation of Amount Raised through IPOs in H2:2021-22 (Per cent) Note: Mainboard IPOs exclude IPOs raised on SME platforms. Sources: SEBI, Bloomberg, Offer documents and RBI staff estimates. were envisaged for capital expenditure and debt bias between mid-October and mid-November 2021. repayment, respectively (Chart IV.14b). In the following months, it depreciated amidst FPI outflows, the strengthening US dollar, increasing IV.1.5. Foreign Exchange Market market expectations of a faster than anticipated The Indian rupee (INR) exhibited two-way movements monetary policy normalisation by the US Fed in H2:2021-22, and depreciated on an average basis and other major AEs, rise in crude oil prices and (Chart IV.15a). The INR traded with an appreciating escalating geopolitical tensions, touching a low of Chart IV.15: INR US$ Movements a: Movements of Indian Rupee and US Dollar Index b: 1 month at the Money Option Implied Volatility Sources: FBIL; Bloomberg; and Thomson Reuters. 68Chapter IV Financial Markets and Liquidity Conditions ` 76.924 per US$ on March 7, 2022. The INR reversed Table IV.4: Nominal and Real Effective some of these losses in the subsequent days with the Exchange Rate Indices (Trade-weighted) correction in crude oil prices and was at ` 75.81 on (Base: 2015-16 = 100) March 31, 2022. Volatility measured by 1-month at Item Index: March Appreciation (+) / 31, 2022 (P) Depreciation (-) (Per cent) the money (ATM) option implied volatility5 of the INR surged, surpassing levels observed during the March 31, 2022 over September (average) 2021 second wave of the pandemic; it however, eased in 40-currency REER 103.3 -2.1 the second half of March (Chart IV.15b). 40-currency NEER 93.5 -1.1 6-currency REER 102.2 -1.5 In terms of the 40-currency nominal effective exchange 6-currency NEER 86.8 -1.2 rate (NEER) and real effective exchange rate (REER), `/US$ 75.8 -3.0 the INR depreciated by 1.1 per cent and 2.1 per cent, P: Provisional. Sources: RBI; and FBIL. respectively, between September 2021 and March 31, 2022 (Table IV.4). INR even as some other emerging market peers faced The nominal and real movements in the Indian rupee sharp depreciation (Chart IV.16). exchange rate against the US dollar were muted in relation to a number of other emerging market Forward premia generally firmed up during H2, currencies. This reflects the underlying stability of the especially for longer maturities (Chart IV.17). Chart IV.16: Cross-Currency Movements a: Movement of Major EME Currencies against US Dollar b: Movement in REER (End-March 2022 over end-September 2021) (February 2022 over September 2021) Sources: RBI; FBIL; IMF; Thomson Reuters; and Bank for International Settlements (BIS). 4 Reference rate published by FBIL. 5 Implied volatility is derived from an option’s price and depicts the markets’ expectations about the future volatility of the currency. 69Monetary Policy Report April 2022 Chart IV.17: Forward Premium Chart IV.18: Non-food Credit Growth of SCBs Source: RBI. Source: Bloomberg. IV.1.6 Credit Market The recovery in bank credit was led by private sector banks that provided the bulk (50..4 per cent) of the Credit offtake picked up during 2021-22, with the incremental y-o-y credit (up to March 25, 2022), gradual return of normalcy after the pandemic. Non- followed by PSBs (44.7 per cent) (Chart IV.19b). food credit extended by scheduled commercial banks (SCBs) rose by 9.7 per cent (y-o-y) as on March 25 (4.5 Credit growth was driven by all the major economic per cent a year ago) (Chart IV.18). sectors6. Credit to agriculture accelerated to 10.4 Chart IV.19: Credit Flow across Bank-Groups a: Growth b: Share in Incremental Credit Source: RBI. 6 Data on non-food credit are based on fortnightly Section 42 return, which covers all scheduled commercial banks (SCBs), while sectoral non-food credit data are based on sector-wise and industry-wise bank credit (SIBC) return, which covers select banks accounting for about 94 per cent of total non-food credit extended by all SCBs. 70 tnec rePChapter IV Financial Markets and Liquidity Conditions Chart IV.20: Sectoral Deployment of Bank Credit a: Sector-wise Credit Growth (y-o-y) b: Share in Incremental Non-food Credit c: Non-food Credit Growth - Kernel Density Estimates Source: RBI and staff estimates. per cent (y-o-y) in February 2022 from 8.6 per cent expansions in its scope, which helped push up credit in February 2021 on the back of a higher target7, growth to micro and small industries to 19.9 per the interest subvention scheme and priority sector cent in February 2022 (3.1 per cent a year ago) and lending. Growth in credit to industry recovered to to medium industries to 71.4 per cent (30.6 per cent 6.5 per cent in February 2022 from a low of 1.0 per a year ago) (Chart IV.21a and b). The Union Budget cent a year ago, aided by higher flows to MSMEs and a 2022-23 has extended the ECLGS to March 2023, with turnaround in large industry. Personal loans remained the guarantee cover increasing by ` 50,000 crore to a the key driver of overall bank credit, with a share of total cover of `5 lakh crore. Credit to large industry 42.7 per cent in incremental offtake (y-o-y) in February emerged out of an extended period of contraction/ 2022 (Chart IV.20a and b). The uptick in credit growth slow growth and recorded 0.5 per cent growth in was seen across banks (Chart IV.20c)8. February 2022, supported by key industries such as Within industry, credit to MSMEs benefitted from engineering; chemicals and chemical products; food the launch of the Emergency Credit Line Guarantee processing; leather and leather products; and rubber, Scheme (ECLGS) in May 2020 and the subsequent plastic, and their products. Infrastructure credit – 38 7 The government raised the target for agriculture credit flow from `15 lakh crore for 2020-21 to `16.5 lakh crore for 2021-22. 8 Based on data for 31 SCBs. 71Monetary Policy Report April 2022 Chart IV.21: Bank Credit Growth in Industry and MSME Sectors a: Growth in Credit to Industry (y-o-y) b: Industry-Financial Year Incremental Credit (up to February 2022) Source: RBI. per cent of the total industrial credit – logged a robust territory in October 2021 and rose sharply to 14.6 growth of 11.9 per cent in February 2022, driven by per cent in February 2022 from 7.0 per cent a year road and power sectors and the government’s push ago. Credit to the trade sector remained strong, to capex. while that to transport operators recovered after Credit expansion in the services sector was led by remaining subdued for over a year. NBFCs and trade NBFCs and trade, which together constitute around sectors were the major contributors to the overall 58 per cent of the total services sector credit. credit growth to the services sector in February 2022 Credit growth to the NBFCs moved out of negative (Chart IV.22a and b). Chart IV.22: Credit Growth in Service Sector a: Growth (y-o-y) b: Contribution of Major Sub-components **Other services include services such as professional services, computer software, tourism, hotels & restaurants, shipping, aviation, mutual fund (MFs), banking and finance other than NBFCs and MFs. Source: RBI. 72Chapter IV Financial Markets and Liquidity Conditions Chart IV.23: Credit Growth in Personal Loans 16 100 12.3 80 12 60 8 40 4 20 0 0 Source: RBI. Personal loans grew by 12.3 per cent in February 2022 followed by vehicle loans and loans against gold (9.6 per cent a year ago), primarily driven by housing, jewellery (Chart IV.23 and Box IV.1). Box IV.1: Retail Lending Behaviour of Banks Retail loans have emerged as the main driver of bank in the outstanding credit of SCBs, displacing industrial credit in recent years and now have the largest share loans (Chart IV1.1a). Within retail, housing loans have Chart IV.1.1: Retail Credit Dynamics a: Sectoral Share b: Share in Personal Loans c: Share in Retail Loans Source: RBI. (contd.) 73 02-rpA 02-yaM 02-nuJ 02-luJ 02-guA 02-peS 02-tcO 02-voN 02-ceD 12-naJ 12-beF 12-raM 12-rpA 12-yaM 12-nuJ 12-luJ 12-guA 12-peS 12-tcO 12-voN 12-ceD 22-naJ 22-beF Housing Vehicleloans Loans against goldjewellery(RHS) Personalloans tnec reP tnec reP 10.3 6.7 26.2 50 40 30 20 10 0 tnec reP 90-rpA 01-nuJ 11-guA 21-tcO 31-ceD 51-beF 61-rpA 71-nuJ 81-guA 91-tcO 02-ceD 22-beF 100 30.5 80 28.9 27.3 60 13.3 40 20 0 Apr-07 Mar-08 Mar-15 Mar-21 Feb-22 Agriculture and allied activities Industry Services Personal loans tnec reP 35.2 4.4 10.0 1.9 47.7 0.8 Consumer durables Housing Education Vehicle loans Credit card outstanding Contingency and other loansMonetary Policy Report April 2022 the largest share (Chart IV.1.1b). The importance of retail Table IV.1.1: Determinants of Banks’ Sectoral Lending loans has increased for both private sector banks (PVBs) (1) (2) (3) and public sector banks (PSBs) (Chart IV.1.1c). Dependent variables Retail loans have been supported by banks’ transformation Explanatory variables Overall Industrial Retail loan from being traditional ‘financial intermediaries’ to lending bank credit loan growth growth growth for consumption purposes, driven by the new generation Lag dependent variable 0.526** 0.219*** 0.160* private sector banks, credit information bureaus, Lag NPA ratio -0.695** -1.625** -1.109** technological and product innovations, and alternate Lag RoA 2.825* 8.316** 3.434** delivery channels (Jappelli and Pagano, 1993). In view Interest rate -3.264*** -4.893*** -3.803*** Lag nominal GDP growth rate 0.404** 0.924** 0.814** of subdued profitability and deleveraging by corporates, constant 0.416*** 0.564*** 0.356** risk-averse banks shifted their focus away from large N 288 288 288 infrastructure and industrial loans towards retail loans AR(1) Test 0.001 0.005 0.004 (Das, 2020). AR(2) Test 0.100 0.112 0.782 Sargan Test 0.076 0.084 0.650 To analyse factors affecting retail credit relative to overall lending and industrial credit, key banking health variables * p<0.1, ** p<0.05, *** p<0.01 Source: RBI staff estimates. (asset quality and profitability) and macroeconomic variables (overall economic activity) are considered for the period 2007-2020 using annual data in a dynamic panel to retail. Overall, as economic activity picks up and with setting, with the sample including both public sector the banking system well capitalised, credit offtake can be and private sector banks (Table IV.1.1). The empirical expected to turn more broad-based. analysis suggests that credit growth to the retail sector References: is less sensitive to asset quality than industrial credit. Das, S. (2020), “Banking Landscape in the 21st Century”, Given the higher incidence of NPAs in industry, risk RBI Bulletin, March. aversion has contributed to credit growth in retail sector outpacing the growth in credit to industry. Furthermore, Jappelli, T., and M. Pagano (1993), “Information Sharing in industrial loans demand tends to be more cyclical relative Credit Markets”, Journal of Finance, 48(5). The asset quality of SCBs improved further during public and private corporates was more than offset 2021-22, with the overall non-performing assets (NPA) by reduction in their commercial paper holdings ratio declining to 6.5 per cent in December 2021 from (Chart IV.25a). Adjusted non-food credit (i.e., banks’ 6.8 per cent a year ago, driven by lower NPAs in credit non-food credit plus non-SLR investments) growth to industry (Chart IV.24). accelerated to 9.1 per cent on March 25 from 4.2 per During H2, the expansion in banks’ non-SLR cent a year ago, mirroring non-food credit dynamics investments in bonds, debentures and shares of (Chart IV.25b). 74Chapter IV Financial Markets and Liquidity Conditions Chart IV.24: Stressed Assets and Non-Performing Assets of SCBs a: Overall Loan Portfolio of SCBs b: Sectoral Non-Performing Assets Source: RBI. Amidst improving credit offtake, growth in banks’ IV.2 Monetary Policy Transmission holdings of government securities decelerated, The accommodative stance of monetary policy, ample pulling down their excess SLR investments to 10.6 per cent of net demand and time liabilities (NDTL) surplus liquidity, and the floating rate loans linked as on February 25, 2022 from 11.0 per cent at end- to marginal cost of funds-based lending rate (MCLR) March 2021 (Chart IV.26). getting reset lower contributed to some further easing Chart IV.25: Non-SLR Investment and Adjusted Non-Food Credit a: Non-SLR Investment b: Adjusted Non-Food Credit Source: RBI. 75Monetary Policy Report April 2022 Chart IV.26 : Excess SLR of Banks *up to February 25, 2022. Source: RBI. in commercial bank’s lending rates in H2:2021-22. In December 2021 from 28.6 per cent in March 2021 and response to the 250 basis points (bps) reduction in the 9.3 per cent in March 2020, which would strengthen policy repo rate since February 2019 (when the current transmission further going forward. Correspondingly, easing phase started), the weighted average lending the share of MCLR-linked loans has come down, rates (WALRs) on fresh and outstanding rupee loans although these still have the largest share (53.1 per have declined by 213 bps and 143 bps, respectively cent in December 2021) (Table IV.6). The sustained (Table IV.5). decline in the MCLRs and the periodic resetting of The proportion of floating rate loans linked to the such loans at lower rates benefitted existing borrowers external benchmarks rose further to 39.2 per cent in and led to a softening of WALR on outstanding loans. Table IV.5: Transmission from the Repo Rate to Banks’ Deposit and Lending Rates (Variation in basis points) Period Repo Rate Term Deposit Rates Lending Rates Median TDR WADTDR 1 - Year WALR WALR (Fresh (Fresh (Outstanding Median (Outstanding Rupee Loans) Deposits) Deposits) MCLR Rupee Loans) February 2019 - September 2019 (Pre-External Benchmark) -110 -9 -8 -30 0 -43 October 2019 – March 2022* (External Benchmark Period) -140 -180 -181 -128 -143 -170 March 2020 - March 2022* (COVID period) -115 -150 -143 -95 -124 -140 February 2019 – March 2022* (Current Easing Cycle) -250 -208 -189 -155 -143 -213 April 2021 –September 2021 0 0 -21 -5 -18 -2 October 2021 – March 2022* 0 0 -5 0 -11 -8 *: Latest data on WALRs and WADTDR pertain to February 2022. WALR: Weighted average lending rate; WADTDR: Weighted average domestic term deposit rate; MCLR: Marginal cost of funds-based lending rate; TDR: Term deposit rate. Source: RBI. 76Chapter IV Financial Markets and Liquidity Conditions micro, small and medium enterprises (MSMEs), in the Table IV.6: Outstanding Floating Rate Rupee Loans case of outstanding rupee loans (Chart IV.27). of SCBs across Interest Rate Benchmarks (Per cent to total) In February 2022, lending rates (outstanding loans) March March June December were the lowest in respect of housing loans, reflecting 2020 2021 2021 2021 the lower risk of default and the availability of Base rate regime 10.2 6.4 6.5 5.3 MCLR regime 77.7 62.8 60.3 53.1 collaterals. Other personal loans, i.e., loans other than External benchmark regime 9.3 28.6 32.2 39.2 housing, vehicle and educational loans are mostly Others 1.7 1.5 0.5 1.9 unsecured and hence they have higher credit risk and Note: Data pertain to 74 scheduled commercial banks. spreads (Chart IV.28). In the case of fresh loans, large Source: RBI. industry got loans at the lowest rates, followed by infrastructure and housing loans9. The reduction in lending rates was seen across most sectors in 2021-22, adding to the softening recorded in Monetary transmission to WALR on fresh rupee loans 2020-21. The decline was the sharpest for agricultural in retail and MSME sectors, where new floating rate loans, infrastructure, large industry and other loans have been mandatorily linked to an external personal loans in the case of fresh rupee loans and benchmark10, registered substantial improvement for infrastructure, other personal loans, vehicle and (Chart IV.29). Chart IV.27: Sector-wise Transmission to WALRs of Domestic Banks a. Fresh Rupee Loans b. Outstanding Rupee Loans 0 -6 -20 -15 -40 -30 -30 -33 -28 -39 -37 -60 -46 -54 -42 -49 -53 -80 -72 -78 -83 -100 -92 -104 -106 -120 -112 *: ‘Other personal loans’ include personal loans other than housing, vehicle, education and credit card loans. Source: RBI. 9 The share of outstanding loans linked to external benchmarks increased from 4.7 per cent in March 2020 to 20.4 per cent in December 2021 for industry (large) and from 8.9 per cent to 20.8 per cent for infrastructure segment. 10 The Reserve Bank mandated that all scheduled commercial banks (excluding regional rural banks) should link all new floating rate personal or retail loans and floating rate loans to micro and small enterprises (MSEs) to an external benchmark, viz., the policy repo rate or 3-month T-bill rate or 6-month T-bill rate or any other benchmark market interest rate published by Financial Benchmarks India Private Ltd. (FBIL) effective October 1, 2019. The directive was extended to medium enterprises effective April 1, 2020. 77 )stniopsisab(noitairaV erutlucirgA )egraL( yrtsudnI sEMSM erutcurtsarfnI edarT gnisuoH elciheV noitacudE *snaol lanosrep rehtO llarevO FY:2020-21 FY:2021-22 (up to February)Monetary Policy Report April 2022 Chart IV.28: Sector-wise WALRs of Domestic Chart IV.29: Transmission to WALR (Fresh Banks (February 2022) Loans) on Personal Loans and Loans to MSMEs (October 2019 - February 2022) 0 -50 -100 -150 -139 -150 -154 -147 -153 -159 -170 -167 -200 -193 -194 -208 -203 -219 -222 -250 -255 -300 Housing Vehicle Education Other MSMEs personal loans Source: RBI. Source: RBI. The spreads charged by domestic banks over the policy transmission to term deposit rates (Chart IV.30a). The repo rate (in the case of loans where the repo rate is median term deposit rate (MTDR) – the prevailing the external benchmark) moderated during H2, and card rates on fresh deposits – has moderated by were the lowest for other personal loans and housing 150 bps since March 2020, led by shorter tenor loans in February 2022 (Table IV.7). deposits of maturity of up to one year (Chart IV.30b). Concomitantly, the weighted average domestic term The external benchmark-based pricing of loans deposit rate (WADTDR) on outstanding deposits (which has hastened adjustments by banks in their declined by 143 bps. Banks with higher WADTDR have cost of funds to maintain net interest margins), weak undertaken more rate cuts in the current easing cycle credit demand and ample surplus liquidity improved (Chart IV.30c). The decline in the MTDR of PvBs exceeded that of Table IV.7: Loans linked to External Benchmark – PSBs, leading to a greater alignment in the levels Spread of WALR (Fresh Rupee Loans) over the Repo Rate of deposit rates across the two bank groups. With (Per cent) improving credit demand, however, banks have Sectors September 2021 February 2022 started pricing in their deposits at higher rates to Public Private Domestic Public Private Domestic mobilise stable funding. As a result, the WADTDR on sector banks banks sector banks banks banks banks fresh deposits has increased by 24 bps since October MSME loans 5.13 3.98 4.72 4.24 3.92 4.07 2021. The median saving deposit rate for domestic Personal loans banks has remained sticky in the range of 2.9 to 3 per Housing 3.14 3.17 3.16 2.92 3.50 3.28 cent since June 2020. Vehicle 3.49 4.09 3.55 3.24 3.82 3.30 Education 4.43 6.03 4.76 4.44 5.09 4.59 The decline in the lending rates (both fresh and Other personal 5.17 3.54 4.97 3.11 4.79 3.19 loans outstanding rupee loans) was higher in the case of Sources: RBI; and RBI staff estimates. PSBs relative to PvBs, contrary to the movements in 78 )stniopsisab(noitairaV Public sector banks Private banks Domestic banksChapter IV Financial Markets and Liquidity Conditions Chart IV.30: Surplus Liquidity, Credit Condition and Transmission to Deposit Rates a. Credit Growth, Deposit Rate and Liquidity Conditions b. Maturity wise Transmission to Median Term c. Transmission to WADTDR at Domestic Bank Level Deposit Rates (March 2020 to March 2022) Sources: RBI; and RBI staff estimates. deposit rates (WADTDR) (Chart IV.31a). Lending rates below PvBs (Chart IV.31b). The transmission to lending (WALRs as well as MCLRs) of PSBs continue to remain and deposit rates was the maximum in the case of Chart IV.31: Bank Group wise Transmission to Lending and Deposit Rates in Current Easing Cycle 11.0 10.0 9.0 8.0 7.0 6.0 Sources: RBI; and RBI staff estimates. 79 tnec reP 91-beF 91-rpA 91-nuJ 91-guA 91-tcO 91-ceD 02-beF 02-rpA 02-nuJ 02-guA 02-tcO 02-ceD 12-beF 12-rpA 12-nuJ 12-guA 12-tcO 12-ceD 22-beF -70 -83 -90 -99 -100 -120 -123 -119 -134 -150 -150 -150 -170 -161 -168 -184 -178 -176 -189 -220 Up to1year 1 to3 year Above 3 years All tenors a. Transmission across Bank-Groups b. Lending Rates of Domestic Banks (Feb 2019 to Feb 2022) WALR(Fresh rupee loans)- PSBs WALR(Fresh rupee loans)- PvBs 1-Year median MCLR- PSBs 1-Year median MCLR- PvBs )stniopsisab(noitairaV Public sector banks Private banks Foreign banks SCBs -100 -150 -135 -135 -145 -143 -143 -155 -170 -200 -189 -189 -208 -213 -223 -250 -260 -300 -288 -319 -350 -357 -400 WADTDR WALR (Fresh WALR 1-Year Median rupee loans) (Outstanding rupee MCLR loans) )stniopsisab(noitairaV -25 6.0 6.5 7.0 7.5 8.0 -75 -125 -175 -225 -275 Public sector banks Private banks Foreign banks SCBs )stniop sisab( RDTDAWniegnahC ) 2 2beF -91beF( WADTDR(per cent) (Feb2019)Monetary Policy Report April 2022 Table IV.8: Interest Rates on Small Savings Instruments – Q1:2022-23 Small Savings Scheme Maturity Spread Average G-sec Formula based Government Difference (years) (Percentage Yield (%) of Rate of Interest Announced Rate (basis points) point) $ Corresponding (%) (applicable of Interest (%) Maturity for Q1:2022-23) for Q1:2022-23 (Dec 2021 -Feb 2022) (1) (2) (3) (4) (5) = (3) + (4) (6) (7) = (6) - (5) Savings Deposit - - - - 4.00 - Public Provident Fund 15 0.25 6.76 7.01 7.10 9 Term Deposits 1 Year 1 0 4.32 4.32 5.50 118 2 Year 2 0 4.76 4.76 5.50 74 3 Year 3 0 5.21 5.21 5.50 29 5 Year 5 0.25 6.10 6.35 6.70 35 Recurring Deposit Account 5 0 5.21 5.21 5.80 59 Monthly Income Scheme 5 0.25 6.07 6.32 6.60 28 Kisan Vikas Patra 124 Months# 0 6.76 6.76 6.90 14 NSC VIII issue 5 0.25 6.24 6.49 6.80 31 Senior Citizens Saving Scheme 5 1.00 6.10 7.10 7.40 30 Sukanya Samriddhi Account Scheme 21 0.75 6.76 7.51 7.60 9 $: Spreads for fixing small saving rates as per Government of India Press Release of February 2016. #: Current maturity is 124 months. Note: Compounding frequency varies across instruments. Sources: Government of India; FBIL; and RBI staff estimates. foreign banks, as a higher share of low cost and lower to time, if any, in the public domain. As part of the duration wholesale deposits in their total liabilities monetary policy and other announcements of April facilitated faster adjustment in interest rates. 8, 2022 certain changes have been effected in the operating procedure to further refine it by improving The Government has left the interest rates on various its flexibility, efficiency in liquidity management and small savings instruments (SSIs) – which are fixed operational convenience, as set out below (Box IV.2). on a quarterly basis with a spread of 0-100 bps over and above G-sec yields of comparable maturities In consonance with the accommodative stance of – unchanged since Q2:2020-21, i.e., for the eighth monetary policy, the Reserve Bank maintained ample successive quarter. In view of the increase in the G-sec surplus liquidity in the system during H2, aimed yields in recent months, the excess of the announced at nurturing and supporting the nascent growth interest rates on SSIs over the respective formula- impulses by ensuring adequate flow of credit to the productive sectors of the economy. Simultaneously, based rates moderated to 9-118 bps for Q1:2022-23 with the objective of restoring the revised liquidity from 42-168 bps in Q4:2021-22 (Table IV.8). management framework – suspended in March 2020 IV.3 Liquidity Conditions and the Operating after the outbreak of COVID-19 – the RBI continued Procedure with rebalancing of liquidity from the passive fixed The RBI Act, 1934 requires the Reserve Bank to place the rate overnight reverse repo window towards longer operating procedure relating to the implementation tenors through VRRR auctions in a gradual, calibrated of monetary policy and changes thereto from time and non-disruptive manner. 80Chapter IV Financial Markets and Liquidity Conditions Box IV.2: Refinements in the Operating Framework of Monetary Policy in India The amendment to Section 17 of the RBI Act in 2018 The SDF rate will be 25 bps below the policy rate, and it enables the Reserve Bank to introduce the Standing will be applicable to overnight deposits at this stage. It Deposit Facility (SDF). By removing the binding collateral would, however, retain the flexibility to absorb liquidity constraint on the central bank, the SDF strengthens the of longer tenors as and when the need arises, with operating framework of monetary policy. The SDF as appropriate pricing. The MSF rate will continue to be 25 the floor of the LAF corridor would provide symmetry bps above the policy repo rate. Thus, the width of the LAF to the operating framework of monetary policy by corridor is restored to the pre-pandemic configuration of introducing a standing absorption facility at the bottom 50 bps, symmetrically around the policy repo rate, which of the LAF corridor, similar to the standing injection tool will be at the centre of the corridor. at the upper end of the corridor, namely the marginal The fixed rate reverse repo (FRRR) rate is retained at standing facility (MSF). Thus, at both ends of the LAF 3.35 per cent. It will remain as part of RBI’s toolkit and corridor, there will be standing facilities – one to absorb its operation will be at the discretion of the RBI for and the other to inject liquidity. Accordingly, access to purposes specified from time to time. The FRRR along SDF and MSF will be at the discretion of banks, unlike with the SDF will impart flexibility to the RBI’s liquidity repo/reverse repo, OMO and CRR which are available at management framework. the discretion of the Reserve Bank. The SDF is also a financial stability tool in addition to its role in liquidity Both MSF and SDF will be available on all days of the management. week, throughout the year. Drivers and Management of Liquidity RBI’s forex operations also sucked out liquidity to the tune of `1.0 lakh crore in H2 on account of FPI Currency demand was the prime source of liquidity outflows, contrary to a substantial injection of `3.0 leakage while drawdown of government cash balances emerged as the main driver of liquidity accretion lakh crore during H111. The drainage of liquidity due during H2. Currency in circulation (CiC) increased by to these factors was to an extent offset by accretion on `2.1 lakh crore during H2 (up to March 25, 2022), driven account of higher government spending to the tune by festival season demand and rabi crop harvesting. of `1.5 lakh crore in H2 (Table IV.9). Open market Table IV.9: Liquidity – Drivers and Management (` crore) 2020-21 2021-2022 Q1 Q2 H1 Q3 Q4* H2* 2021-22* Drivers (i) CiC -4,06,452 -1,26,266 54,921 -71,344 -61,794 -1,48,617 -2,10,411 -2,81,755 (ii) Net Forex Purchases 5,10,516 1,60,843 1,42,395 3,03,238 -17,242 -79,136 -96,378 2,06,860 (iii) GoI Cash Balances -1,81,999 -2,23,740 -5,600 -2,29,340 1,34,537 19,430 1,53,967 -75,373 Management (i) Net OMO Purchases 3,13,295 1,38,965 97,960 2,36,925 -15,060 -7,880 -22,940 2,13,985 (ii) CRR Balances -1,46,617 29,392 -16,470 12,922 -77,606 32,996 -44,611 -31,689 (iii) Net LAF Operations -1,52,302 -60,759 -2,86,162 -3,46,921 60,823 1,65,269 2,26,092 -1,20,829 *: Data are up to March 25, 2022. Note: Data pertain to the last Friday of the respective period. Source: RBI. 11 The two-year USD-INR sell/buy swap of US$ 5 billion conducted on March 8, 2022 with a view to elongating the maturity profile of the forward book (deferring liquidity injection through forward delivery to the far leg) mopped up liquidity amounting to `0.39 lakh crore. 81Monetary Policy Report April 2022 operations (OMOs) drained liquidity in H2 in contrast ample liquidity surplus, the absence of additional to a sizeable injection in H1 from the secondary borrowing for goods and services tax (GST) market G-Sec Acquisition Programme (G-SAP) compensation and the expected expansion of liquidity (Box IV.3). G-SAP was discontinued in H2, given the on account of higher government spending. Box IV.3: Impact of G-Sec Acquisition Programme Asset purchase programs (APPs) have been undertaken G-SAP auctions was larger than conventional OMOs; by several central banks (including EMEs) following and (iii) purchases included both liquid and illiquid the COVID-19 outbreak to ease monetary and financial securities (RBI, 2021). The market response to the nine conditions in support of economic recovery (IMF, 2020). G-SAP auctions was favourable (Chart IV.3.1). The last APPs lower yields through two main channels, viz., (i) two auctions were liquidity neutral with purchases being the supply channel by which an APP announcement can offset by simultaneous sales of an identical amount immediately moderate the risk premium in anticipation (special OMOs). of reduced net supply of government bonds in the market; To assess the announcement effect of the G-SAP on and (ii) the signalling channel as market participants may yields in an event study (ES) framework, daily changes perceive the recourse to an APP as an indication that the (close - close ) in the benchmark 10-year G-sec yield economic outlook is weak necessitating lower policy rates t t-1 (Gsec) for April-September 2021 (period during which for a longer period (Arora et al., 2021). G-SAP was conducted) are regressed on the proximate In the Indian context, the Reserve Bank purchased macroeconomic and financial market drivers of yields: G-secs of `2.2 lakh crore under G-SAP in H1:2021- (i) change in yield on the previous day to account for 22 to anchor yield expectations in the context of the hysteresis effects (persistence); (ii) changes in US 10- large borrowing programme of the Government. Asset year bond yield (US10Y) and crude oil prices (Crude) to purchases under G-SAP were different from regular open capture the impact of global factors on domestic yields; market operation (OMO) purchases as (i) these provided and (iii) domestic inflation surprises ((cid:507) Inflation) which an upfront commitment on amounts in contrast to is defined as the difference between actual CPI inflation regular OMOs, which are discretionary; (ii) the size of and consensus forecasts. The impact of G-SAP on yields is captured by inclusion of a dummy for the policy day (April 4) when G-SAP was announced (GSAP_GS) and for Chart IV.3.1: Bid-Offer Ratio of G-SAP Auctions each of the respective G-SAP announcement (GSAP_IA) dates12. The estimated coefficients suggest a statistically significant impact of domestic and global factors (domestic inflation, US bond yields and crude oil prices) on yields (Table IV.3.1). The G-SAP announcements cumulatively Source: RBI. (contd.) 12 Idiosyncratic events/factors which impacted yields during this period – conversion/switch operation conducted on April 15 (D_Switch) and the introduction of a new 10-year benchmark announced on July 5 (D_NB) – are also controlled for in the regression. 82Chapter IV Financial Markets and Liquidity Conditions softened the benchmark bond yield by 9 basis points in Table IV.3.1: G-SAP Impact on 10-year G-Sec Yields spite of gross market borrowings remaining elevated for Variables Coefficient the second successive year and recurrent supply shocks Constant -0.000 that kept inflation elevated. Thus, G-SAP operations Lag (-1) -0.084 facilitated congenial and orderly financing conditions (cid:507) US10Y (-1) 0.107** (cid:507) Crude_Oil 0.003*** that provided a conducive environment for the domestic (cid:507) Inflation 0.026*** recovery. G-SAP_GS -0.037*** (cid:520)(cid:3)GSAP -0.092*** References: D-Switch 0.100*** D-New Benchmark 0.097*** International Monetary Fund (2020), Global Financial Diagnostic tests ( p-value) Stability Report, October. BG LM test for autocorrelation of residuals 0.397 Arora. R., S. Gungor, J. Nesrallah, G. O. Leblanc and J. Breusch-Pagan-Godfrey – Heteroscedasticity Test 0.987 Witmer (2021), "The Impact of the Bank of Canada’s Note: *, **, *** denote significance at 10, 5 and 1 per cent level, Government Bond Purchase Program", Bank of Canada, respectively. Sample period for the analysis is April 1-September 30, 2021 Source: RBI staff estimates. Staff Analytical Note 2021-23. Liquidity absorption through the reverse repo them as the main liquidity management operation, mirrored movements in government cash balances, complemented by fine tuning operations of varying given the latter’s transient role in driving frictional sizes and maturities (3-28 days). The 14-day VRRR liquidity (Chart IV.32). auction amount was increased in a calibrated and pre- announced path from `4.0 lakh crore on October 8 to Liquidity Rebalancing `7.5 lakh crore by December 31, 2021. Due to their The Reserve Bank progressively enhanced the size higher remuneration relative to the fixed rate reverse of the 14-day VRRR auctions in H2 to re-establish repos, the VRRR auctions drew favourable market responses. Reflecting these developments, the amount Chart IV.32: Absorption under Reverse Repo and absorbed under the fixed rate reverse repo declined GoI Cash Balance to a daily average of `2.0 lakh crore in H2 from `4.7 lakh crore in H1, with a concomitant increase in absorption through variable rates (both main and fine- tuning operations) to `6.2 lakh crore from `2.3 lakh crore over the same period (Chart IV.33). The Reserve Bank’s commitment to flexibly conduct fine tuning operations was reinforced through three variable rate repo (VRR) auctions of 1-3-day maturity, cumulatively injecting `2.0 lakh crore during January 20-24, 2022 to address transient liquidity tightness on account of higher than anticipated collections under the GST. As a step towards rebalancing the liquidity surplus, it was decided to provide one more option to banks to Source: RBI. prepay the outstanding amount of funds availed under 83Monetary Policy Report April 2022 With the progressive return of normalcy, and in Chart IV.33: Surplus Liquidity - Average order to restore the revised liquidity management Absorption under the LAF framework, the RBI announced on February 10, 2022 that (i) the variable rate repo (VRR) operations of varying tenors would be conducted as and when warranted by the evolving liquidity and financial conditions within the CRR maintenance cycle; (ii) VRRs and VRRRs of 14-day tenor will operate as the main liquidity management tool based on liquidity conditions, conducted to coincide with the CRR maintenance cycle; (iii) the main operations will be supported by fine-tuning operations to tide over any unanticipated liquidity changes during the reserve maintenance period while auctions of longer maturity will also be conducted, if required; and Source: RBI. (iv) effective March 1, 2022, the windows for fixed rate reverse repo and the MSF operations would be the targeted long term repo operations (TLTRO 1.0 and available during 17.30-23.59 hours on all days (as 2.0) conducted during March-April 2020. Accordingly, against 09.00-23.59 hours since March 30, 2020 as banks cumulatively returned `39,882 crore in two an interim measure to provide market participants tranches – `2,434 crore in December 2021 over and greater flexibility in their liquidity management in above `37,348 crore paid earlier in November 2020. view of COVID-19). Market participants were advised Moreover, given the limited recourse by banks to the to shift their balances out of the fixed rate reverse marginal standing facility (MSF) in the post-pandemic repo into VRRR auctions and avail the automated period due to surplus liquidity conditions, the normal sweep-in and sweep-out (ASISO) facility in the dispensation of allowing banks to dip up to 2 per cent e-Kuber portal for operational convenience13. (instead of 3 per cent) of their NDTL was reinstated IV.4 Conclusion effective January 1, 2022. At the same time, the RBI extended the deadlines of key targeted liquidity Domestic financial markets have moved broadly facilities, given the needs of the stressed sectors: in sync with the accommodative monetary policy special long-term repo operations (SLTRO) facility stance. The rebalancing of liquidity from the fixed for small finance banks (SFBs) were made available rate window to variable rate reverse repo auctions till December 31, 2021, while also making it on tap; is firming up money market rates. Bond yields the liquidity facilities of `50,000 crore to ease access have risen from historic lows on the back of higher to emergency health services and `15,000 crore for crude oil prices and the expected monetary policy contact-intensive sectors were extended up to June normalisation by advanced economy central banks. 30, 2022 from March 31, 2022. Nevertheless, financial conditions remain conducive 13 ASISO is an optional facility introduced in August 2020 to provide greater flexibility to banks in managing their day-end CRR balances under which banks pre-set a specific (or range) amount that they wish to maintain at the end of the day. Any shortfall or excess balances maintained will automatically trigger MSF or reverse repo bids, as the case may be, under the ASISO facility. 84Chapter IV Financial Markets and Liquidity Conditions to growth and credit offtake is gaining traction. commodity markets, which are witnessing volatility The RBI’s market operations remain supportive of due to worsening geopolitical situations and monetary the recovery. Going forward, they will contextually policy normalisation in the major AEs, so as to insulate factor in the developments in global financial and domestic financial markets from spillovers. 85V. External Environment The global economy has been buffeted by severe shocks since the October 2021 MPR. The sharp increase in geopolitical tensions since January 2022 escalating into a full-fledged war in February is imposing a threat to the world economy and its financial system architecture. Meanwhile, inflation is at multi-decadal highs and increasingly getting persistent across major advanced economies and several emerging market economies. The global economy has been buffeted by severe into a full-fledged war in February is imposing a bigger shocks since the October 2021 MPR. In November, threat to the world economy and its financial system the highly transmissible Omicron variant of the virus architecture. Meanwhile, inflation is at multi-decadal emerged, but its impact on lives and livelihoods highs and increasingly getting persistent across major turned out to be benign relative to earlier waves advanced economies (AEs) and several emerging and, on the global economy, transient. Furthermore, market economies (EMEs). The tectonic upward shift supply chain disruptions intensified, posing a risk to in commodity prices, including food and energy, due the global recovery. More recently, the sharp increase to the war is making the macroeconomic picture in geopolitical tensions since January 2022 escalating murkier (Box V.1). Box V.1: Impact of the Russia-Ukraine War on the Global Macroeconomy Geopolitical hostilities in Ukraine are casting a strong edible oil, wheat, minerals and metals produced by these downside to the global macroeconomy. The immediate two countries (Chart V.1.2). direct hit on commodities and financial markets has Global food inflation and food security are hostage to aggravated, with financial sanctions and retaliation. The the war, as are energy-dependent nations and fertiliser closure of shipping routes and air space, suspension importers, including India. There are second-order of logistic and shipping services and shutting down spillovers too – it is estimated that the global light vehicle of pipelines, on account of sanctions/apprehensions/ production would be reduced by 2.6 million units in 2022 voluntary private decisions are creating a new wave of and 2023 as the conflict has disrupted supplies of vehicle supply disruptions. This is likely to further add to freight components, including electric power communication costs, ultimately feeding into inflation and impacting parts, palladium, aluminium, nickel and semiconductor- trade and output. A surge in geopolitical risk is associated grade neon. with significant economic contraction, particularly in If commodity and financial market shocks persist for at emerging market economies (Cheng and Chiu, 2018). least one year, it is estimated that in 2022, global GDP Russia and Ukraine were the 11th and 55th largest growth could be reduced by more than 1 percentage economies in the world in 2020, accounting for about point and the global consumer price inflation could be 1.7 per cent and 0.2 per cent, respectively, of the world’s raised by around 2.5 percentage points (OECD, 2022). nominal GDP. Their shares in world exports at 2.3 per cent Europe is likely to be the most impacted in view of high and 0.3 per cent, respectively, notwithstanding, they have dependence on energy imports. Moreover, it is seeing a a dominant influence on supplies of key commodities, massive refugee influx. The OECD estimates that the cost resulting in an outsized impact on inflation, trade and of accommodating 3 million refugees – the total inflow in output at the global level (Chart V.1.1). The world runs the first three weeks of the war – in 2022 would be around a high exposure to fuel, gas, some agro, wood products, 0.25 per cent of the European Union’s GDP. (Contd.) 8866Chapter V External Environment Chart V.1.1: World Dependence on Russia and Ukraine Sources: UNCTAD; Trade Map, International Trade Centre; and RBI staff estimates. The longer-term economic ramifications of the war/ of payments systems and opaque diversification of sanctions could be deterrence to decarbonisation, higher foreign exchange reserves. defence spending, move towards autarky, fragmentation Chart V.1.2: Export Profile – Major Countries a: Russia b: Ukraine Source: World Integrated Trade Solution, World Bank. References: OECD (2022), “Economic and Social Impacts and Policy Cheng, C. H. J. and Chiu, C.-W(J.) (2018): “How Important Implications of the War in Ukraine”, Economic Outlook, are Global Geopolitical Risks to Emerging Countries?” Interim Report, March. International Economics, doi:10.1016/j.inteco.2018.05.002 8877Monetary Policy Report April 2022 V.1 Global Economic Conditions Table V.1: Real GDP Growth (Per cent) While there was a pick-up in the momentum of global growth in Q4:2021, more recent high frequency Country Q1: Q2: Q3: Q4: 2020 2021 2022 2023 2021 2021 2021 2021 (E) (P) (P) indicators point to some loss of pace in Q1:2022. Quarter-on-quarter, seasonally adjusted annualised rate (Q-o-q, SAAR) The US economy registered impressive gains in Canada 4.8 -3.6 5.5 6.7 - - - - Q4:2021 primarily due to strong consumer/business Euro area -0.5 9.1 9.3 1.0 - - - - spending and non-residential fixed investment Japan -2.2 2.4 -2.8 4.6 - - - - South Korea 7.1 3.1 1.3 5.0 - - - - (Table V.1). Furthermore, private inventory investment UK -4.6 24.6 4.0 5.2 - - - - and exports also contributed positively. As a result, US US 6.3 6.7 2.3 6.9 - - - - GDP grew by 5.7 per cent in 2021 – the highest since Year-on-year 1984 – as against a contraction of 3.4 per cent in 2020. Advanced Economies As 2022 began, the rapid spread of the Omicron variant Canada 0.2 11.7 3.8 3.3 -5.2 4.8 4.1 2.8 appeared to be causing a slowdown in some sectors of Euro area -0.9 14.6 4.0 4.6 -6.4 5.3 3.9 2.5 Japan -1.8 7.3 1.2 0.4 -4.5 1.8 3.3 1.8 the economy but the virus spread has been receding South Korea 1.9 6.0 4.0 4.2 -0.9 4.0 3.0 2.9 since mid-January. The S&P Global US composite UK -5.0 24.6 7.0 6.6 -9.3 7.4 4.7 2.3 Purchasing Managers’ Index (PMI) after touching an US 0.5 12.2 4.9 5.5 -3.4 5.7 4.0 2.6 18-month low of 51.1 in January bounced back to Emerging Market Economies 55.9 in February 2022 as virus containment measures Brazil 1.3 12.3 4.0 1.6 -3.9 4.6 0.3 1.6 China 18.3 7.9 4.9 4.0 2.2 8.1 4.8 5.2 were scaled back and further rose to an 8-month high India 2.5 20.3 8.5 5.4 -6.6 8.9 9.0 7.1 in March with broad-based acceleration in activity. Indonesia -0.7 7.1 3.5 5.0 -2.0 3.7 5.6 6.0 The US labour market continued to tighten, with Philippines -3.9 12.0 6.9 7.7 -9.6 5.6 6.3 6.9 Russia -1.8 -0.7 10.5 -3.0 4.7 2.8 2.1 wages rising 4.5 per cent in 2021 – the fastest pace South Africa -2.4 19.6 2.9 1.7 -6.4 4.9 1.9 1.4 since 1983 – although the labour force participation Thailand -2.4 7.7 -0.2 1.9 -6.2 1.6 4.1 4.7 rate remained below pre-pandemic levels. Stronger Memo: household balance sheets, rising employment and World 2020 2021 (E) 2022 (P) 2023 (P) adaptation to the pandemic by businesses are factors Year-on-year supporting the outlook whereas the war and the Output -3.1 5.9 4.4 3.8 pandemic are the major headwinds. Trade Volume -8.2 9.3 6.0 4.9 The Euro area’s GDP grew by 1.0 per cent (q-o-q, saar) E: Estimate P: Projection. Note: India's data correspond to fiscal year (April-March); E.g., 2020 in Q4:2021, its slowest rate in three quarters, as the pertains to April 2020-March 2021. Sources: Official statistical agencies; Bloomberg; IMF WEO Update, January Omicron variant’s spread necessitated restrictions, 2022; and RBI staff estimates. creating labour shortages and denting consumer confidence. The composite PMI for the Euro zone In the UK, GDP grew 5.2 per cent (q-o-q, saar) in registered its highest monthly jump in five months Q4:2021 but still remained 0.1 per cent below its pre- in February 2022 as containment measures abated pandemic level, i.e., Q4:2019. As the economic impact but slid in March as business activity slowed down of the Omicron variant ebbed, GDP increased to 0.8 particularly in manufacturing. The growth outlook for per cent above its pre-pandemic level in January 2022, 2022 is overcast by the war and persistently high and driven by growth in all sectors, including consumer- rising energy costs. facing services, production and construction. The 8888Chapter V External Environment unemployment rate continued to decline despite but it remains below its pre-pandemic level of output. closure of the furlough scheme at end-September 2021. There was a resurgence of COVID-19 cases in the The composite PMI hit an 8-month high of 59.9 in beginning of 2022. The au Jibun Bank Japan composite February 2022 driven by strong recovery in consumer PMI improved to 50.3 in March 2022 from 45.8 in spending on travel, leisure and entertainment and February – first rise in output after three consecutive rose further in March. The growth outlook is, however, months of contraction with services continuing to be mired in uncertainty as the soaring of energy prices in decline. Japan’s economy would likely recuperate due to the war portends adversely for already high as containment measures fade but the war may pose inflation. a downside. Japan’s GDP grew by 4.6 per cent (q-o-q, saar) in Moving to EMEs, the Chinese economy grew by 8.1 Q4:2021, in contrast to the 2.8 per cent contraction per cent in 2021, exceeding the government’s target logged in Q3. The upturn marked the strongest pace of above 6 per cent; however, growth of 4.0 per cent of quarterly growth in a year, as both household (y-o-y) in Q4:2021 was the slowest pace of expansion consumption and business investment revived amidst since Q2:2020 (Table V.2). The government’s zero a decline in COVID-19 cases, easing restrictions and tolerance approach to COVID-19 has exacerbated the advancing vaccination campaign. Overall, the pandemic-related disruptions and muted consumer Japanese economy expanded by 1.8 per cent in 2021 spending, while the real estate sector is beset with a Table V.2: Select Macroeconomic Indicators for BRICS Economies Real GDP Growth Country 2020 2021(E) 2022(P) General Govt. Country 2020 2021(E) 2022(P) Rate (Per cent) Gross Debt Brazil -3.9 4.6 0.3 (Per cent of GDP) Brazil# 98.9 90.6 90.2 Russia -3.0 4.7 2.8 Russia 19.3 17.9 17.9 India -6.6 8.9 9.0 India 89.6 90.6 88.8 China 2.2 8.1 4.8 China 66.3 68.9 72.1 South Africa -6.4 4.9 1.9 South Africa 69.4 68.8 72.3 CPI Inflation Rate Country 2020 2021(E) 2022(P) Current account Country 2020 2021(E) 2022(P) (Per cent) balance Brazil 3.2 7.7 5.3 (Per cent of GDP) Brazil -1.8 -0.52 -1.72 Russia 3.4 5.9 4.8 Russia 2.4 5.7 4.4 India 6.1 5.4 4.9 India 0.9 -1.0 -1.4 China 2.4 1.1 1.8 China 1.8 1.6 1.5 South Africa 3.3 4.4 4.5 South Africa 2.0 2.9 -0.9 General Govt. Net Country 2020 2021(E) 2022(P) Forex Reserves* Country 2020 2021 2022 Lending/Borrowing (in US$ billion) (Per cent of GDP) Brazil -13.4 -6.2 -7.4 Brazil 355.6 362.2 357.7 Russia -4.0 -0.6 0.0 Russia 596.1 630.6 630.2 India -12.8 -11.3 -9.7 India 588.4 635.3 633.8 China -11.2 -7.5 -6.8 China 3536 3578.2 3576.6 South Africa -10.8 -8.4 -7.0 South Africa 54.2 57.821 57.8 E: Estimate. P: Projection. *: Forex reserves for 2022 pertains to February 2022 except Russia (January 2022) #: Gross debt refers to the nonfinancial public sector, excluding Eletrobras and Petrobras, and includes sovereign debt held by the central bank. Notes: 1. India's data correspond to fiscal year (April-March). 2.The imputed CPI prints for April and May 2020 for India have been regarded as a break in the CPI series. Sources: Official statistical agencies; WEO October 2021 database and January 2022 Update, IMF; Fiscal Monitor Update, October 2021, IMF; and IRFCL, IMF. 8899Monetary Policy Report April 2022 steep downturn in the property sector. In March, China than offset a slowdown in the services sector amidst registered its highest daily infection tally, with several cooling retail sales. GDP expanded 4.7 per cent in regions including Shanghai going into lockdown. The 2021, recording the strongest upturn since 2008. In Caixin China general manufacturing PMI was 48.1 February 2022, the composite PMI was at a 7-month in March, lowest since February 2020 amid the new high of 50.8 but slid in March 2022 to its lowest level wave of COVID-19 flare-ups. Looking ahead, several since May 2020, registering a marked contraction weaknesses lurk in the economy, ranging from rising in business activity. Furthermore, international production and raw material costs to a doubtful sanctions are expected to lead to a sharp downward demand recovery and the war. The government has plunge in the economy. set a growth target of 5.5 per cent for 2022, the lowest South-east Asian economies recovered in Q4:2021 as since 1991. pandemic-induced restrictions eased and inoculation Brazil’s GDP growth decelerated for the second rates improved. The manufacturing PMI for the consecutive quarter to 1.6 per cent (y-o-y) in Q4:2021, ASEAN economies in March 2022 eased to a 6-month with industry and agriculture registering a decline. low amidst softer demand conditions. The region Labour market indicators showed consistent job faces headwinds due to the war and its fallout on recovery. Exports have benefited from robust global commodity prices, especially wheat and potassic demand for commodities. Supply bottlenecks, higher fertiliser. interest rates and policy uncertainty have, however, The OECD composite leading indicators (CLIs) slowed the pace of recovery. The manufacturing PMI available up to February 2022 suggest moderate hit a 6-month high in March but overall remained deceleration across most major AEs and divergent in contraction in Q1:2022. Going forward, elevated movements for major EMEs (Chart V.1a). The global interest rates and a fragile fiscal position weigh on composite PMI suggests easing of momentum at end activity, with the ongoing war-related uncertainty of Q1:2022 with the March reading moderating to remaining a key risk to the outlook. 52.7 as output growth slowed in both services and South Africa’s GDP growth decelerated to 1.7 per manufacturing (Chart V.1b). cent (y-o-y) in Q4:2021. In January 2022, South Africa World trade momentum has moderated since H2:2021 experienced its heaviest rainfall on record, which as pent-up demand normalised (Chart V.2a). This is caused extensive crop damage and was declared a corroborated by the World Trade Organization (WTO)’s national disaster by the authorities. The composite Goods Trade Barometer reading of 98.7 in December PMI for March, however, signalled expansion for the 2021, which is below the barometer’s baseline value third successive month due to increase in employment of 100. The WTO, in an October 2021 release, expected even as inflation weighed on activity. Looking ahead, merchandise trade growth to moderate to 4.7 per cent the growth outlook is fraught with risks, including the in 2022 from 10.8 per cent in 2021. The Baltic Dry emergence of new COVID-19 variants, low vaccination Index – a measure of shipping costs for a wide variety levels, poor jobs outlook and continued disruptions to of bulk commodities such as coal, iron ore and grain – power supply. has moderated after peaking in October 2021. Rising The Russian economy ended 2021 on a strong footing uncertainty and disruptions due to the war, however, on sturdier industrial production growth, which more have put pressure on shipping costs (Chart V.2b). 9900Chapter V External Environment Chart V.1: Survey Indicators a: OECD CLIs b: Composite PMI Sources: OECD; and Bloomberg. V.2 Commodity Prices and Inflation to an 8-year high in early-March. Notwithstanding some moderation thereafter, the index increased by Following a blip in November 2021 on account of the 23.5 per cent between September 2021 and March Omicron’s onset, global commodity prices resumed 2022. rallying in December with the outbreak of the war sending fresh shock waves across markets from end- The food price index of the Food and Agriculture February. As a result, prices of most commodities Organization (FAO) increased by 8.9 per cent soared, pushing the Bloomberg commodity price index between September 2021 and February 2022 Chart V.2: World Trade Volume a: World Trade Volume: Relative Contribution b: World Trade Volume and Baltic Dry Index Sources: CPB Netherlands; and CEIC. 9911Monetary Policy Report April 2022 (Chart V.3a). Prices hit an all-time high in February, first week of March. Prices have remained volatile rising 20.7 per cent (y-o-y) primarily on strong thereafter fluctuating around US$110 per barrel. vegetable oil and dairy prices – the former reaching a Notwithstanding the volatility, brent crude oil prices new record on concerns over global supply flows. For surged by 38 per cent in Q1:2022. sugar, however, favourable production prospects in Base metal prices, measured by Bloomberg’s base major exporting countries have kept price pressures metal spot index, increased by 25.0 per cent between muted since December. Food prices are likely to pick September 2021 and March 2022 (Chart V.4). From up further in coming months as fertiliser prices end-December there has been a broad-based pick up have soared in March on fears of prolonged in metal prices, underpinned by improved demand disruption in global supply of potash and nitrogen prospects as also strained supplies due to disruptions crop nutrients. in a few major metal exporting countries. The war Crude oil prices ended 2021 51.4 per cent higher year- upended the markets and most metals scaled multi- on-year, on the back of a rally in October and early year highs, with aluminium and nickel leading. November. They resurged in early 2022, breaching Following the unprecedented surge in prices, the US$90 per barrel towards end-January – the first London Metal Exchange suspended nickel trading time in seven years – as demand remained robust for over a week in the second week of March. Gold while supply faced capacity constraints and escalated prices inched up and stayed around the psychological geopolitical tensions (Chart V.3b). With the Russia- level of US$1,800 per troy ounce in Q4:2021 and Ukraine war propelling risks of outright supply losses January 2022. Bullion prices spurted from February on and OPEC plus providing no respite, crude oil prices increased flight to safety before paring some gains in rocketed to a 14-year high of US$133 per barrel in the the second half of March. Chart V.3: Commodity Prices a: Food Price Indices b: Energy and Crude Oil Prices Sources: FAO; and World Bank. 9922Chapter V External Environment Chart V.4: Metal Price Indices Source: Bloomberg. Inflation ratcheted up across economies on cost Table V.3: Inflation push pressures from persistent supply chain (Per cent) bottlenecks, high commodity prices and spiralling Country Inflation Q1:2021 Q2:2021 Q3:2021 Q4:2021 Q1:2022 Target wage pressures. Headline inflation has soared Advanced Economies to multi-decadal highs across most AEs, barring Canada 2.0 1.4 3.4 4.1 4.7 5.4 Japan; for EMEs too, barring China and Indonesia, Euro area 2.0 1.0 1.8 2.9 4.7 6.2 it continued to hover at elevated levels (Table V.3). Japan 2.0 -0.5 -0.8 -0.2 0.5 0.7 South Korea 2.0 1.4 2.5 2.5 3.6 3.8 High energy and food costs are the major drivers for UK 2.0 0.6 2.0 2.8 4.9 5.9 inflation in AEs besides, price pressures in durable US 2.0 1.8 3.9 4.3 5.5 6.2 goods, particularly used cars and trucks, and services Emerging Market Economies such as rents. For most EMEs, however, inflation is Brazil 3.50 ± 1.5 5.3 7.7 9.6 10.5 10.5 essentially driven by supply shocks with demand- Russia 4.0 5.6 6.0 6.9 8.3 8.9 pull pressures remaining relatively weak, given the India 4.0 ± 2.0 4.9 5.6 5.1 5.0 6.0 China – 0.0 1.1 0.8 1.8 0.9 slack in economic activity. South Africa 3.0 - 6.0 3.1 4.8 4.8 5.5 5.7 Mexico 3.0 ± 1.0 4.0 6.0 5.8 7.0 7.2 In the US, headline inflation in terms of both the CPI Indonesia 3.0 ± 1.0 1.4 1.5 1.6 1.8 2.3 and the personal consumption expenditure (PCE) price Philippines 3.0 ± 1.0 4.0 4.0 4.1 3.6 3.3 index – the Federal Reserve (Fed)’s preferred measure Thailand 1.0 - 3.0 -0.5 2.4 0.7 2.4 4.7 Turkey 5.0 15.6 17.1 19.3 25.8 54.8 of inflation – edged up to fresh 40-year high of 7.9 per Notes: (1) Quarterly inflation is the simple average of inflation in each cent and 6.4 per cent, respectively, in February 2022 month of the quarter. For Q1:2022, the full quarterly average (Chart V.5a). The monthly momentum of inflation is only for the Euro area, South Korea, Indonesia, Thailand, Philippines and Turkey while for others it is Jan-Feb average. quickened from October 2021 primarily on surging (2) Inflation for US is in terms of year-on-year change in personal consumption expenditure price index. energy, food and durable goods prices. Moreover, (3) The Bank of Canada aims to keep inflation at the 2 per cent spiralling rents and building wage pressures mirrored mid-point of an inflation control target range of 1-3 per cent. (4) Brazil’s inflation target for 2021 was 3.75 ± 1.5 per cent. in the multi-decadal high annual wage growth are Sources: Central bank websites; and Bloomberg. 9933Monetary Policy Report April 2022 fuelling broad-based price pressures. Core CPI inflation CPI inflation in the UK accelerated since Q4:2021 to has also accelerated with shelter, used cars and trucks 6.2 per cent in February 2022 – its highest in the Office remaining the major contributors for most months. In of National Statistic’s series which began in January February, other core components such as recreation, 19971. Transport cost due to soaring energy prices household furnishings and operations, personal care, contributed 1.6 percentage points to the increase. and airline fares also registered increases. Inflationary pressures are high for food and durable goods as well, while broadening to the services sector In the Euro area, CPI inflation has been treading above partly due to change in value added tax (VAT) rates for the European Central Bank (ECB)’s target of 2 per cent hospitality services. since July 2021, with the headline reading scaling historical high of 7.5 per cent in March 2022. Steep Inflation remained relatively benign in Japan though increase in energy prices, especially of natural gas, deflation ended in September 2021. In February, inflation accelerated to a 3-year high of 0.9 per cent remained the major driver with ripple effects for other as high energy prices overshadowed the effects of sectors. High costs of non-energy industrial goods as weak housing cost and low telecom charges. The pick- also rising food prices, and high transportation and up notwithstanding, inflation remains way below the fertiliser costs have been fuelling price pressures. Bank of Japan (BoJ)’s 2 per cent target. Market-based measures of longer-term inflation expectations, however, have remained broadly stable Among major EMEs, inflation in Brazil and Russia has at just below 2 per cent, thereby supporting the ECB’s risen to levels more than twice their respective targets expectation of moderation in prices over the course of since Q4:2021 despite monetary policy being tightened the year once supply bottlenecks ease. since March 2021 (Chart V.5b). In Brazil, increase in prices Chart V.5: CPI Inflation – Select Economies a: Advanced Economies b: Emerging Market Economies Sources: Official statistical agencies; and Bloomberg. 1 As per the historical modelled series, the February 2022 print is the highest since the March 1992 reading of 7.1 per cent. 9944Chapter V External Environment have become more widespread in recent months. Apart Table V.4: Fiscal Support in Response to COVID-19 from elevated costs for industrial goods, acceleration (Up to September 2021) in services inflation has also added to the upside. CPI (Amount in US$ billion; Per cent as proportion of GDP) inflation in Russia rose to 9.2 per cent in February 2022 Country Amount Per cent with cost-push pressures stemming from commodity Advanced Economies prices, labour shortages and capacity shortfalls spiralling Canada 327 19.9 European Union 1,361 10.5 amidst a steady demand recovery. In South Africa, CPI Japan 2,273 45.1 inflation has edged up but remains within the central UK 975 36.0 bank’s target range. In January, however, inflation US 5,838 27.9 eased to 5.7 per cent following some softening in Emerging Market Economies Brazil 222 15.4 the cost of fuel and health services and remained Russia 96 6.5 steady in February. In China, unlike in other BRICS India 275 10.3 economies, CPI inflation remained subdued reflecting China 903 6.1 South Africa 30 9.4 broad moderation in both food, especially pork, and World 16,910 16.4 non-food prices. Even core inflation has remained Source: IMF. muted due to weakening demand for services amidst sporadic COVID-19 flare-ups and associated stringent response to the pandemic is estimated at US$19.0 restrictions. Producer price inflation has been easing trillion or 18.4 per cent of global GDP, of which since November after hitting a 26-year high in October, US$16.1 trillion was by AE central banks and US$2.9 as price stabilisation measures cooled off the rally in trillion by EME central banks. raw material prices. In the US, the Fed began tapering monthly asset Recent research2 suggests that global inflation in 2022 purchases of US$120 billion in mid-November 2021 could be 1.5 percentage points higher because of the and wound-up purchases in four months. In its increase in shipping costs in 2021. This is because the January meeting, the Fed issued a set of principles impact of rise in shipping costs peaks in 12 months and for reducing the size of its balance sheet: (i) target lasts up to 18 months. The increased supply disruptions range for the federal funds rate would be the primary due to the war and China lockdowns could further means of adjusting the stance of monetary policy; exacerbate the inflation upside. (ii) reduction in balance sheet size would commence V.3 Monetary Policy Stance after a lift-off of interest rates; (iii) size of holdings would go down by adjusting the amount of re- COVID-19 saw an unprecedented policy response investment of maturing securities; (iv) to eventually mounted by governments and central banks. The IMF estimates that up to September 2021, US$16.9 trillion hold quantum of securities as needed to implement or 16.4 per cent of global GDP had been pledged as monetary policy efficiently and effectively in an fiscal support in response to the pandemic, with ample reserves regime; and (v) to eventually hold US$14.5 trillion by AEs and US$2.4 trillion by EMEs, primarily Treasury securities. In its March 2022 including the low-income developing countries meeting, Fed raised the target range for the Federal (Table V.4). The total monetary support offered in Funds rate by 25 bps to 0.25-0.5 per cent, the first 2 Carrière-Swallow, Y., Deb, P., Furceri, D., Jiménez, D., & Ostry, J. D. (2022). “Shipping Costs and Inflation”, IMF WP/22/61, March 9955Monetary Policy Report April 2022 rate hike since December 2018. To operationalise the would stop re-investing for its maturing stock of rate hike, the Fed revised up the interest rates on government bonds. It would begin selling from its reserve balance and overnight reverse repurchase portfolio of government bonds only after the Bank agreement by 25 bps each to 0.4 per cent and 0.3 Rate reaches 1 per cent, conditional on economic per cent, respectively. According to the Summary of circumstances at that time. The BoE also announced Economic Projections released in March 2022, the that it would stop re-investing for maturing corporate majority of FOMC participants expect interest rate bonds and that it would initiate a programme of to be 1.75-2.0 per cent by end-2022, i.e., a further 150 corporate bond sales to be completed not earlier than bps hike this year. end-2023. In March 2022, the BoE raised the Bank In its October meeting, the ECB announced a Rate by a further 25 bps to 0.75 per cent, suggesting slower pace of asset purchases under the Pandemic that further modest tightening would be appropriate Emergency Purchase Programme (PEPP) in Q4:2021 in the coming months. than in the previous two quarters. In December, it In its December meeting, BoJ extended the Special further reduced the pace of purchases for Q1:2022 Program to Support Financing in Response to the and announced discontinuation of PEPP at end- Novel Coronavirus by six months until end- September March 2022 but extended the reinvestment horizon 2022. It also signalled the completion of additional by one year at least until end-2024. To smoothen purchases of commercial paper and corporate bonds the transition from end of PEPP purchases, the ECB by end-March 2022 and reversion to the pre-pandemic announced doubling of monthly purchase under quantum of purchases from April 2022. In its March the Asset Purchase Programme (APP) to 40 billion meeting, the BoJ said that inflation is likely to remain (approximately US$45.3 billion)3 in Q2:2022, to in positive territory for some time but maintained an gradually revert to 20 billion (approximately US$22.7 overall dovish stance. billion) by October 2022. In its March meeting, the ECB lowered the monthly purchases under APP from Among other AE central banks, the Reserve Bank of 40 billion (approximately US$43.9 billion) in each Australia discontinued its yield curve control policy month of the quarter to a reduced schedule of 40 in November 2021 and halted weekly bond purchases billion in April, 30 billion (approximately US$33 in early February 2022. The Bank of Canada ended billion) in May and 20 billion (approximately US$22 its weekly bond-buying programme in October 2021 billion) in June and announced end of APP purchases and raised rate by 25 bps in March 2022 to 0.5 per in Q3:2022. cent. The Bank of Korea raised rates in November The Bank of England (BoE) maintained a pause on 2021 and January 2022 by 25 bps each to 1.25 per its policy rate in its November meeting. In December cent, while the Reserve Bank of New Zealand has 2021, it raised the Bank Rate by 15 bps and in February cumulatively increased its policy rate by 75 bps since by another 25 bps. Also, in keeping with the guidance October 2021, taking it up to 1.0 per cent in February of its August 2021 MPR4, the BoE announced that it 2022 (Chart V.6a). 3 The US$ approximations for all amounts mentioned in another currency in this Chapter are based on the exchange rate (Bloomberg) on the date of announcement of the measure. 4 To begin unwinding asset purchases only after the Bank Rate reached 0.5 per cent. 9966Chapter V External Environment On the other hand, the People’s Bank of China (PBoC) The Bank of Russia (BoR) had raised its key rate by 275 effected a 50 bps cut in the reserve requirement ratio bps in three steps between October 2021 and early from December 15, 2021, which injected 1.2 trillion February 2022 on heightening inflation concerns. On yuan (approximately $188.3 billion) liquidity into the February 28, 2022, in an emergency move, the BoR economy. The PBoC also initiated a monetary policy increased its key rate by 10.5 percentage points to 20 easing cycle by reducing the 1-year Loan Prime Rate per cent to compensate for a sharp rouble depreciation (LPR) by 5 bps in December, followed by a 10 bps cut and inflation risks amidst the geopolitical upheaval. in January 2022, supported by a 5 bps reduction in It also undertook unbound fine-tuning operations the 5-year LPR and 10 bps reductions in the interest to meet all liquidity needs of the banking system, rate on 1-year medium-term lending facility loans and besides other measures to shore up liquidity and the 7-day reverse repurchase agreements. Since then, the financial markets. As the structural liquidity deficit PBoC has maintained a pause. in the banking system continued to build, the BoR In contrast, most other EME central banks continued reduced the reserve requirement for banks to 2 per with policy tightening in Q4:2021 and into Q1:2022. cent, releasing 2.7 trillion rouble (approximately The Banco Central do Brazil (BCB) effected three US$26 billion) liquidity. The sanctions have precluded consecutive 150 bps hike in October 2021, December BoR’s access to its currency reserves in dollar and 2021 and February 2022 and a 100 bps hike in March, euros. Moreover, exclusion of major Russian banks thereby, raising the Selic rate to 11.75 per cent. The from the Society for Worldwide Interbank Financial South African Reserve Bank raised its policy rate by 25 Telecommunications (SWIFT) would affect financial bps in November 2021 – first hike in three years – and transactions with the rest of the world. The BoR followed it up with two more 25 bps hikes in January maintained a pause on policy rate in its March meeting and March 2022, taking the policy rate to 4.25 per cent but announced purchase of government bonds to (Chart V.6b). limit financial stability risks. Chart V.6: Policy Rate Changes – Select Central Banks a: Advanced Economies b: Emerging Market Economies Source: Central bank websites. 9977Monetary Policy Report April 2022 Banco de México hiked its policy rate in two steps It registered net gains in Q4 while ending 2021 almost for a total of 75 bps in Q4:2021 and by another 27 per cent per cent higher – the third successive 100 bps in Q1:2022 through 50 bps hikes each in year of double digit gains. Escalating Russia-Ukraine February and March, taking the benchmark rate to tensions alongside Fed’s hawkish pivot triggered 6.5 per cent. The central banks of Chile, Peru and sharp sell-offs in January, which intensified in late Hungary continued their monetary tightening. The February and then rallied from mid-March to end of central bank of Turkey, on the other hand, followed the quarter. up the 100 bps reduction in key rate in September European stock markets remained broadly supported with cuts of 200 bps in October and 100 bps each in in Q4:2021 by strong quarterly earnings and the ECB’s November and December. It has, however, maintained highly accommodative stance. In Q1:2022, however, a pause in 2022 so far, with its benchmark interest markets turned extremely volatile, reversing all early rate at 14 per cent. To normalise excess liquidity gains on inflationary risks from soaring energy prices conditions, Bank Indonesia began a 300 bps increase and heightened geopolitical tensions. From second in domestic currency reserve requirement for week of March, European indices recovered partially commercial banks in three steps from March to on conflict resolution optimism. September 2022. The Nikkei continued to lag other major AE stock V.4 Global Financial Markets indices, largely due to a relatively slower recovery Global financial markets remained largely buoyant, in the Japanese economy. It ended Q4 in negative although the Omicron variant and policy pivots territory and plunged to a 15-month low in end- towards quicker normalisation caused sharp shifts in January as market priced in faster rate hikes by the US Q4:2021. Geopolitical tensions, however, took centre Fed. The downtrend steepened further, with Nikkei stage in Q1:2022, plunging them into a tailspin. dipping to a 16-month low in early March following outbreak of the war, but positive developments lifted Equity markets in most AEs and a few EMEs, shed sentiments thereafter. the resilience of Q4 and went into a downswing for most part of Q1 before recouping some ground from The UK stock indices, on the other hand, have mid-March (Chart V.7a). Bond yields had hardened strengthened since Q4, albeit with intermittent across maturities, although slid briefly towards end- corrections. Since mid-February, however, markets February as investors dashed to safe haven. The US trimmed gains, tracking global cues, to close the dollar strengthened on hawkish Fed statements and month in the red. This was followed by a sharp safe haven demand, while EME currencies broadly plunge in the first week of March amid turbulent weakened until mid-March. geopolitical conditions. In line with other AEs, stock markets in the UK picked up from the second week Among AEs, US equities rallied in October and early of March. November, driven by upbeat corporate earnings data for Q3:2021 before giving up some gains towards EME stock markets underperformed developed end-November as Omicron and escalating headline markets, with the MSCI EME stock index posting inflation unnerved investors. The correction, negative returns in Q4:2021 as also for the full year. however, proved short-lived, with the US S&P index Country-specific factors weighed heavily on market paring losses in December as fears over the severity sentiments along with the threats to the recovery and economic impact of the new variant dissipated. from Omicron. Weakness intensified in Q1:2022 as 9988Chapter V External Environment Chart V.7: Equity Markets a: Equity Indices (MSCI) b: Change in Equity Indices -2.2 Japan -3.4 UK 1.84.2 US -4.9 10.6 Euro area -9.2 6.2 China -10.6 2.0 SouthAfrica 2.4 14.7 Brazil -5.5 14.5 -7.7 Russia -28.6 India -1.5 0.5 -35 -30 -25 -20 -15 -10 -5 0 5 10 15 20 Per cent Q4:2021 Q1:2022 Sources: Bloomberg; and RBI staff estimates. most EME equity indices, barring a few commodity The US 10-year bond yield raced up above 2.0 per exporters, traded in the red on concerns over early cent in early February before retreating on safe haven policy tightening, mounting inflationary risks and demand. With the tightening cycle commencing, worsening geopolitical conditions (Chart V.7b). Russian the 10-year bond yield moved up from mid-March, stocks plummeted by more than 30 per cent after the hitting a 3-year high of 2.5 per cent in the last week outbreak of war, following which trading was halted of the month. Tracking global cues, Japanese bond for almost a month before resuming gradually from yields jumped to their highest level in six years in March 24. For most other EME markets, optimism on February, while German 10-year bond yield moved intermittent peace talks revived confidence from mid- decisively into positive territory for the first time March, resulting in modest rise. since May 2019 before dipping back into negative zone in early March amidst heightened tensions. In treasury markets, bond yields across major AEs From the second week of March, however, bond broadly rose in Q4:2021, as investors tussled with yields across AEs started increasing again, as the protracted inflation risks and withdrawal of monetary ECB pivoted towards normalisation, while the UK accommodation by major central banks (Chart V.8a). effected its third consecutive hike. The increase was particularly sharp at the front end of the curve. As a result, the yield curve (10-year Bond yields in major EMEs remained highly volatile over 2-year) which was steepening till September, and traded with a hardening bias as financial flattened since Q4. The significant hardening in bond conditions tightened (Chart V.8b). 10-year bond yields yields since mid-December, however, reversed briefly in major EMEs show strong co-movement with the US in end-February and early March on flight to safety. 10-year treasury yield, though the strength of the co- Bond yields shifted higher thereafter in response to movement varies across countries (Box V.2). Chinese hawkish signals from the US Fed. bond yields, however, have generally softened on 9999 seimonocEdecnavdA seimonocEtekraMgnigremEMonetary Policy Report April 2022 Chart V.8: Bond Yields a: 10-year Sovereign Bond Yields in Select AEs b: 10-year Sovereign Bond Yields in Select EMEs Source: Bloomberg. rising monetary accommodation. Bond yields have notable spike in Russia, followed by some softening in hardened for most EMEs from mid-February, with a second half of March. Box V.2: Interest Rate Spillovers from the US to Emerging Market Economies The US long-term yields impact other countries through Chart V.2.1: Change in Bond Yields various channels, with consequent portfolio rebalancing (January 2022 over July 2021) and capital outflows putting pressure on emerging market exchange rates and bond prices (Chart V.2.1). Correlation of movements in 10-year government bond yields of the US and eight EMEs5 viz., Brazil, Russia, India, China, South Africa, Indonesia, Mexico and Philippines and one AE6, i.e., Hong Kong is positive and significant (Table V.2.1). The forecast error variance decomposition (FEVD) based on a vector autoregression (VAR)7 examines sensitivity of long-term bond yields in EMEs to changes in US bond yields (Belke et. al, 2017). Measures of spillover intensities from the US to other Source: Thomson Reuters. countries and vice versa are estimated by using a spillover (Contd.) 5 Covering BRICS and all constituents of the “fragile five” of 2013, barring Turkey for which data was not available for the full sample. 6 Due to its currency’s peg to the dollar and being a regional financial hub, Hong Kong is a conduit of transmission of US yields to a broad set of EMEs in the ASEAN region. 7 VAR framework has been used as it allows all variables to be considered endogenous – considering the possibility of spillback effects among EMEs as well as to the US primarily through trade, financial, and commodity price channels. Further, to control for the potential spillovers from market volatility and linkages between bond yields and exchange rate, VIX, Brent crude prices and MSCI EME currency index were used as exogenous variables in the model. 110000Chapter V External Environment Table V.2.1: Correlation between 10-Year Bond Yields US India Brazil South Africa China Russia Hong Kong Philippines Mexico Indonesia US 1.0 India 0.2* 1.0 Brazil 0.2* 0.1* 1.0 South Africa 0.2* 0.1 0.4* 1.0 China 0.1 0.3* 0.0 0.1 1.0 Russia 0.0 0.0 0.1 0.2* 0.0 1.0 Hong Kong 0.8* 0.3* 0.2* 0.3* 0.2* 0.1 1.0 Philippines 0.2* 0.2* 0.2* 0.3* 0.1 0.1 0.2* 1.0 Mexico 0.4* 0.2* 0.3* 0.5* 0.1* 0.2* 0.4* 0.4* 1.0 Indonesia 0.2* 0.1 0.4* 0.4* -0.1 0.1 0.1 0.4* 0.4* 1.0 *: Statistically significant at 1 per cent level. Note: Based on data for the period May 2003 to February 2022. Source: RBI staff estimates. index (Diebold and Yilmaz, 2009). The Total Spillover to the US bond yield leads to significant positive reactions Index (TSI)8 in our estimate measures the proportion of in bond yields of most EMEs under consideration up to overall change in yields in the peer group that is due to two months ahead (Chart V.2.2). shocks to other countries’ yields9. The long-term co-movement in bond yields among The estimated generalised impulse responses for the countries, with the US generating strong spillovers have VAR10 suggest that one standard deviation positive shock ramifications for financial and real variables in most Table V.2.2: Spillover during May 2003 to February 2022 US India Brazil South China Russia Hong Philippines Mexico Indonesia From Africa Kong Others US 45.8 3.0 2.9 2.4 1.7 1.0 27.9 2.2 10.2 2.9 54.2 India 6.0 67.4 2.3 3.5 6.7 0.2 7.5 2.1 1.6 2.7 32.6 Brazil 6.0 0.8 58.5 10.0 2.4 2.4 3.6 1.0 8.7 6.7 41.5 South Africa 2.9 0.1 8.7 52.4 0.4 1.9 3.4 6.4 10.7 13.0 47.6 China 5.1 5.9 1.0 1.3 73.0 1.5 5.2 1.4 1.8 3.7 27.0 Russia 0.6 1.0 2.1 4.8 0.0 75.3 3.0 3.7 4.3 5.3 24.7 Hong Kong 30.6 3.2 2.1 2.8 1.9 1.9 45.6 1.7 7.3 2.7 54.4 Philippines 5.2 2.1 0.8 6.9 0.9 2.8 3.5 57.5 9.3 10.9 42.5 Mexico 14.1 0.5 6.2 9.1 1.0 2.9 7.8 8.1 44.1 6.1 55.9 Indonesia 5.6 0.6 3.9 12.6 3.8 1.3 3.5 7.7 7.3 53.8 46.2 Contribution to others 76.2 17.2 30.1 53.4 18.9 15.9 65.3 34.3 61.2 54.0 426.5 Contribution including own 122.0 84.7 88.6 105.8 91.9 91.2 110.9 91.8 105.3 107.9 Directional Spillover Index 62.5% 20.3% 34.0% 50.5% 20.6% 17.4% 58.9% 37.4% 58.1% 50.0% Total Spillover Index 42.6% Note: The ijth entry in the Table V.2.2 is the estimated contribution to the forecast error variance of country i coming from innovations to country j. Hence the off-diagonal column sums (labelled Contributions to Others) or row sums (labelled Contributions from Others), when totalled across countries, give the numerator of the Total Spillover Index. Similarly, the column sums or row sums (including diagonals), when totalled across countries, give the denominator of the Total Spillover Index. Directional spillover from country i to others is given by the ratio of ith country’s contribution to others over total contribution of ith country including own. Source: RBI staff estimates. (Contd.) 8 The TSI for N countries is: TSI (H) = , where is the normalised value of H-step ahead FEVD , so that 9 To measure the portion of TSI that comes from ith country to all other countries, a Directional Spillover Index (DSIi) is calculated as DSI (H) = i 10 The results are based on a VAR model of order 6 (lag length selected based on length criteria and diagnostic checks) estimated on the first difference of all the variables under consideration. The regression diagnostics – no autocorrelation and constant variance in errors – are found to be satisfactory. 110011Monetary Policy Report April 2022 Chart V.2.2: Accumulated Response to Shocks ( Generalized One S.D. Innovations ± 2 S.E.s) Emanating from the US Accumulated Response of India to US Innovation Accumulated Response of Brazil to US Innovation Accumulated Response of South Africa to US Innovation .10 .40 .16 .08 .30 .12 .06 .20 .08 .04 .02 .10 .04 .00 .00 .00 1 2 3 1 2 3 1 2 3 Accumulated Response of China to US Innovation Accumulated Response of Russia to US Innovation Accumulated Response of Hong Kong to US Innovation .20 .25 .06 .04 .10 .20 .02 .00 .15 .00 .10 1 2 3 1 2 3 1 2 3 Accumulated Response of Philippines to US Innovation Accumulated Response of Mexico to US Innovation Accumulated Response of Indonesia to US Innovation .25 .28 .30 .20 .24 .20 .20 .15 .16 .10 .12 .10 .05 .08 .00 .00 1 2 3 1 2 3 1 2 3 EMEs. Yet, own shocks have the highest contribution to Economies to Emerging Asia”, ADBI Working Paper No. yield movements even for EMEs. 705, March Diebold, F. X., & Yilmaz, K. (2009). Measuring Financial References: Asset Return and Volatility Spillovers, with Application to Belke, A., Dubova, I., and Volz, U. (2017) “Long- Global Equity Markets. The Economic Journal, 119(534), term Interest Rate Spillovers from Major Developed 158-171. In the currency markets, the US dollar rallied in market sentiments imparting volatility. EME strongly in Q4:2021 on Fed policy pivot (Chart currencies moved in reverse tandem and broadly V.9a). In Q1, after a brief spell of correction in early depreciated, barring a few commodity exporters. January, the US dollar recovered strongly but hit a The index, however, moved up from mid-March. The patch of volatility. From the latter half of February, MSCI Emerging Market Currency Index increased however, it rose steadily on safe haven demand due by 0.7 per cent in Q4:2021 and changed negligibly to the ongoing geopolitical upheaval, in addition in Q1:2022. There has been retrenchment in capital to the anticipated US policy rate lift-off in March. flows since Q4:2021 culminating into net outflows in It remained elevated in March with fluctuations March (Chart V.9b). 110022Chapter V External Environment Chart V.9: Currency Movements and Capital Flows a: Currency Indices b: Portfolio Flows to EMEs Sources: Bloomberg; and IIF. V.5 Conclusion Monetary authorities have begun exiting from the financial conditions have overwhelmed the global extraordinary accommodation prompted by the once- outlook. With increasing risks to growth and financial in-a-century COVID-19 crisis. The Russia-Ukraine war stability, policy authorities need to steer a knife-edge and its ramifications for global growth, inflation and course to avoid a crash landing. 110033