Monetary Policy Report - September 2022

Published under Section 45ZM of the Reserve Bank of India Act, 1934 Monetary Policy Report SEPTEMBER 2022 Reserve Bank of India MumbaiContents Chapter I: Macroeconomic Outlook 1 I.1: Key Developments since the April 2022 MPR 1 I.2: The Outlook for Inflation 6 I.3: The Outlook for Growth 10 I.4: Balance of Risks 12 I.5: Conclusion 14 Box I.1: Macroeconomic Implications of Low Global Growth and High Global Inflation 5 Box I.2: Global Cost-Push Spillovers on Inflation: Insights from World Input-Output Tables 8 Chapter II: Prices and Costs 15 II.1: Consumer Prices 16 II.2: Drivers of Inflation 20 II.3: Costs 32 II.4: Conclusion 35 Box II.1: Inflation and Inflation Uncertainty in India 18 Box II.2: An Examination of the Rural Prices and Wages Dynamics in India 33 Chapter III: Demand and Output 36 III.1: Aggregate Demand 36 III.2: Aggregate Supply 48 III.3: Conclusion 57 Box III.1: Drivers of India’s Merchandise Exports and Imports 46 Chapter IV: Financial Markets and Liquidity Conditions 58 IV.1: Domestic Financial Markets 58 IV.2: Monetary Policy Transmission 75 IV.3: Liquidity Conditions and the Operating Procedure of Monetary Policy 79 IV.4: Conclusion 81 Box IV.1: Monetary Policy Surprises and Financial Markets 62 Chapter V: External Environment 82 V.1: Global Economic Conditions 82 V.2: Commodity Prices and Inflation 85 V.3: Monetary Policy Stance 88 V.4: Global Financial Markets 91 V.5: Conclusion 94 Box V.1: High Inflation and Aggressive Monetary Tightening: Soft or Hard Landing? 89 iABBREVIATIONS AEs - Advanced Economies CLI - Composite Leading Indicator AEs - Advance Estimates CMIE - Centre for Monitoring Indian Economy AIDC - Agriculture Infrastructure and Development Cess COVID-19 - Coronavirus Disease 2019 APP - Asset Purchase Programme CP - Commercial Paper ASEAN - Association of Southeast Asian CPB - Central Planning Bureau Nations CPI - Consumer Price Index ATF - Aviation Turbine Fuel CPI-AL - Consumer Price Index for ATM - At the money Agricultural Labourers BCD - Basic Customs Duty CPI-IW - Consumer Price Index for Industrial BE - Budget Estimates Workers BEI - Business Expectations Index CPI-RL - Consumer Price Index for Rural BIES - Business Inflation Expectations Labourers Survey CRR - Cash Reserve Ratio BIS - Bank for International Settlements CU - Capacity Utilisation BoE - Bank of England DCA - Department of Consumer Affairs BoJ - Bank of Japan DGCA - Directorate General of Civil Aviation bps - Basis Points DGCI&S - Directorate General of Commercial BRICS - Brazil, Russia, India, China and Intelligence and Statistics South Africa DI - Diffusion Index BSE - Bombay Stock Exchange DII - Domestic Institutional Investor CACP - Commission for Agricultural Costs EBIT - Earnings Before Interest and Taxes and Prices EBLR - External Benchmark Lending Rate CAG - Comptroller and Auditor General ECB - European Central Bank CCIL - Clearing Corporation of India Limited ECBs - External Commercial Borrowings CD - Certificate of Deposit ECI - Eight Core Industries CDS - Credit Default Swap ECLGS - Emergency Credit Line Guarantee CGA - Controller General of Accounts Scheme CI - Confidence Interval ECT - Error Correction Term CiC - Currency in Circulation EIA - Energy Information Administration CII - Confederation of Indian Industry EMEs - Emerging Market Economies iiiiiiMonetary Policy Report September 2022 EPFO - Employees’ Provident Fund GST - Goods and Services Tax Organisation GVA - Gross Value Added FAO - Food and Agriculture Organization H1 - First Half of the Financial Year FBIL - Financial Benchmarks India Pvt. Ltd (April-September) FCNR(B) - Foreign Currency Non-Resident H2 - Second Half of the Financial Year (Bank) (October-March) FDI - Foreign Direct Investment HFI - High Frequency Indicator Fed - Federal Reserve HSD - High-Speed Diesel FICCI - Federation of Indian Chambers of ICIO - Inter Country Input Output Commerce and Industry ICR - Interest Coverage Ratio FIMMDA - Fixed Income Money Market and IIF - Institute of International Finance Derivatives Association of India IIP - Index of Industrial Production FIs - Financial Institutions IMD - India Meteorological Department FL - Family Labour IMF - International Monetary Fund FMCG - Fast-Moving Consumer Goods INR - Indian Rupee FOMC - Federal Open Market Committee IOCL - Indian Oil Corporation Limited FPI - Foreign Portfolio Investment/ Investor IPO - Initial Public Offering FRE - First Revised Estimate IRDAI - Insurance Regulatory and Development Authority FRRR - Fixed Rate Reverse Repo IRFCL - International Reserves and Foreign F-TRAC - FIMMDA Trade Reporting and Currency Liquidity Confirmation System IT - Information Technology FTSE - Financial Times Stock Exchange GDP - Gross Domestic Product JSE - Johannesburg Stock Exchange GFCE - Government Final Consumption LAF - Liquidity Adjustment Facility Expenditure LIC - Life Insurance Corporation of India GFCF - Gross Fixed Capital Formation LMT - Lakh Metric Tonnes GFD - Gross Fiscal Deficit LPA - Long Period Average GM - Genetically Modified LPG - Liquefied Petroleum Gas GNDI - Gross National Disposable Income LPR - Loan Prime Rate GoI - Government of India MCLR - Marginal Cost of Funds Based GSDP - Gross State Domestic Product Lending Rate G-Secs - Government Securities MFs - Mutual Funds iivvAbbreviations MGNREGA - Mahatma Gandhi National Rural OECD - Organisation for Economic Employment Guarantee Act Co-operation and Development MMRP - Modified Mixed Reference Period OIS - Overnight Indexed Swaps MoAFW - Ministry of Agriculture and Farmers’ OMCs - Oil Marketing Companies Welfare OMO - Open Market Operations MOEX - Moscow Exchange OPEC - Organization of the Petroleum Exporting Countries MoH&FW - Ministry of Health and Family Welfare OTC - Over-the-Counter m-o-m - Month-on-Month PA - Provisional Accounts 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 PDS - Public Distribution System MSCI - Morgan Stanley Capital International PE - Provisional Estimates MSF - Marginal Standing Facility PEPP - Pandemic Emergency Purchase MSMEs - Micro, Small and Medium Programme Enterprises PFCE - Private Final Consumption MSP - Minimum Support Price Expenditure MTDR - Median Term Deposit Rate PIB - Press Information Bureau NBFCs - Non-Banking Financial Companies PMG - Pooled Mean Group NCAER - National Council of Applied PMGKAY - Pradhan Mantri Garib Kalyan Anna Economic Research Yojana NDS - Negotiated Dealing System PMI - Purchasing Managers’ Index NDTL - Net Demand and Time Liabilities POL - Petroleum, Oil and Lubricants NEER - Nominal Effective Exchange Rate POSOCO - Power System Operation NPA - Non-Performing Asset Corporation Limited NSC - National Savings Certificate PPAC - Petroleum Planning and Analysis Cell NSDL - National Securities Depository PRN - Production Weighted Rainfall Index Limited PSB - Public Sector Bank NSO - National Statistical Office PSU - Public Sector Undertaking NSSO - National Sample Survey Office PvB - Private Sector Bank ODOP - One District One Product Q1 - First Quarter vvMonetary Policy Report September 2022 Q2 - Second Quarter SWM - South-west Monsoon Q3 - Third Quarter TBs - Treasury Bill Q4 - Fourth Quarter TREPS - Tri-party Repo Dealing System q-o-q - Quarter-on-Quarter TRQ - Tariff Rate Quota QPM - Quarterly Projection Model UK - United Kingdom RBI - Reserve Bank of India UNCTAD - United Nations Conference on Trade RD - Revenue Deficit and Development RE - Revised Estimates US - United States RECO - Revenue Expenditure to Capital US$ - US dollar Outlay USA - United States of America REER - Real Effective Exchange Rate VAR - Vector Autoregression RHS - Right Hand Side VAT - Value Added Tax RL - Rural Labourers VRR - Variable Rate Repo RoW - Rest of the World VRRR - Variable Rate Reverse Repo S&P - Standard and Poor WAC - Weighted Average Coupon SAAR - Seasonally Adjusted Annualised Rate WACR - Weighted Average Call Money Rate SCB - Scheduled Commercial Bank WADR - Weighted Average Discount Rate SDF - Standing Deposit Facility WADTDR - Weighted Average Domestic Term SEBI - Securities and Exchange Board of Deposit Rate India WALR - Weighted Average Lending Rate SGS - State Government Securities WAM - Weighted Average Maturity SIAM - Society of Indian Automobile Manufacturers WAR - Weighted Average Rate SIBC - Sector-wise and Industry-wise Bank WEO - World Economic Outlook Credit WMA - Ways and Means Advances SLR - Statutory Liquidity Ratio WPI - Wholesale Price Index SSE - Shanghai Stock Exchange WTO - World Trade Organization SSI - Small Savings Instruments y-o-y - Year-on-Year STR - Short Term Repo YTD - Year to Date STU - Stocks-to-Use vviiI. Macroeconomic Outlook Aggregate supply conditions are improving. This augurs well for demand ahead of the festival season. Consumer price inflation is ruling above the upper threshold around the target. Monetary policy has moved into the withdrawal of accommodation mode and remains focussed to ensure that inflation returns to the target while supporting growth. The daunting global environment imparts considerable uncertainty to the outlook. I.1 Key Developments since the April 2022 MPR sharply by 21 per cent and 18 per cent, respectively, since end-March (upto September 27, 2022) amidst Since the release of the April 2022 Monetary Policy high volatility. In currency markets, the US dollar has Report (MPR), the global economic environment strengthened to a 20-year high while all other major has been marked by slowing growth with rising currencies have depreciated. risks of recession, elevated inflationary pressures, and tightening financial conditions engendered by Turning to the domestic economy, real gross aggressive and synchronised monetary policy actions domestic product (GDP) rose by 13.5 per cent (y-o-y) and stances. For emerging market economies (EMEs), in Q1: 2022-23, driven by base effects, even as these developments have translated into currency momentum slipped due to the drag from net exports depreciations brought on by a surging US dollar and and restrained government spending. Aggregate capital outflows, leading to reserve losses. The conflict supply conditions have been steadily improving and in Ukraine lingers on and the pandemic continues this augurs well for demand, both urban and rural, to weigh on economic activity even as issues in ahead of the festival season. The late pick-up in green transition, real and financial fragmentation, south-west monsoon and the recent spread of it to trade restrictions and reshoring pose formidable deficient regions is enabling a catch-up in kharif challenges to the global economy. Financial markets sowing, though paddy and pulses remain undersown remain volatile and global spillovers pose significant relative to a year ago. Manufacturing is steadily headwinds. gaining strength and services are posting strong growth, led by contact-sensitive sectors. Brent crude prices remain at elevated levels, given the tight demand-supply balance, despite recent Inflationary pressures, however, persisted at elevated correction. Global food prices have declined by 14 per levels during H1:2022-23 and remain a key policy cent from an all-time high in March but are ruling 8 per concern. Consumer price index (CPI) inflation has cent over last year’s level1. The Bloomberg commodity been at or above the upper tolerance threshold of 6 index was 10 per cent higher on September 27 per cent since January 2022, driven by adverse supply (year-on-year (y-o-y) basis), notwithstanding some shocks emanating from geopolitical tensions. While easing since June. Sovereign bond yields have inflation has eased from its April peak of 7.8 per hardened and reached multi-year highs in major cent, it remains at unacceptably high levels. In order advanced economies (AEs) as investors brace for to anchor inflationary expectations and contain the the future course of monetary policy across the second round effects, the Reserve Bank of India (RBI) world. Yield curves have inverted, foretelling future narrowed the policy corridor in April and the Monetary recession. Equity markets in AEs and EMEs corrected Policy Committee (MPC) increased the policy repo 1 Based on Food and Agriculture Organisation’s (FAO’s) food price index for August 2022. 1Monetary Policy Report September 2022 rate by 140 basis points (bps) during May-August. With the CPI inflation print of March 2022 rising Monetary policy remains focussed on withdrawal of sharply to 7 per cent and significant upside risks accommodation. to the near-term trajectory from higher food, crude oil and commodity prices materialising due to Monetary Policy Committee: April-September 2022 geopolitical tensions and sanctions, the MPC decided During April-September 2022, the MPC met four times, to hold an off-cycle meeting in May 2022. It noted including an off-cycle meeting in May 2022. At the time that while economic activity was resilient, inflation of the MPC meeting in April 2022, the global economic at elevated levels warranted resolute and calibrated and financial environment had turned challenging due steps to anchor inflation expectations and contain to the sharp jump in international commodity prices second round effects. The MPC voted unanimously to and uncertainties around the pace of monetary policy increase the policy repo rate by 40 bps and reiterated normalisation globally. CPI inflation was at or above the stance as set out in the April resolution. the upper threshold of 6 per cent for two successive By the June 2022 MPC meeting, CPI inflation had months in January and February 2022. The MPC risen further to 7.8 per cent in the April 2022 print, assessed that the ratcheting up of geopolitical tensions, with considerable uncertainty around the outlook on the generalised hardening of global commodity prices, account of the geopolitical situation. The MPC was the likelihood of prolonged supply chain disruptions, of the view that continued shocks to food inflation, dislocations in trade and capital flows, divergent elevated international crude oil prices and pending monetary policy responses and volatility in global pass-through of input costs to selling prices were financial markets posed sizeable upside risks to the likely to sustain pressures on headline inflation. inflation trajectory and downside risks to domestic Accordingly, the inflation forecast for 2022-23 was growth. Accordingly, the inflation forecast for 2022-23 revised upwards by 100 bps from the April meeting was raised by 120 bps (relative to the February 2022 to 6.7 per cent. Against this backdrop, the MPC judged projections) to 5.7 per cent while the real GDP growth that there was a need for calibrated monetary policy forecast was revised downward by 60 bps to 7.2 per action to keep inflation expectations anchored and cent. Faced with the twin challenge of high inflation restrain the broadening of price pressures. Accordingly, and worsening growth outlook, the MPC decided to it unanimously decided to increase the policy repo keep the policy repo rate unchanged at 4 per cent. rate by 50 bps. The MPC focused the stance of policy Although still accommodative, the stance of monetary on withdrawal of accommodation. policy focused on withdrawal of accommodation to ensure that inflation remains within the target going At the time of the MPC’s August 2022 meeting, CPI forward, while supporting growth. Concomitantly, the inflation had eased to 7 per cent during May-June Reserve Bank introduced the standing deposit facility 2022 from 7.8 per cent in April but remained above (SDF) at 40 bps above the fixed rate reverse repo rate the upper tolerance threshold of 6 per cent. The MPC as the floor of the liquidity adjustment facility (LAF) observed that while there was some let up in global corridor, thus making the corridor symmetrical with commodity prices, spillovers from geopolitical shocks a width of +/- 25 bps around the policy repo rate were imparting considerable uncertainty to the (see Chapter IV).2 inflation trajectory. Domestic economic activity was 2 To manage the excess liquidity effectively during the pandemic phase, the LAF corridor was made asymmetric during March-April 2020, with reverse repo rate at 65 bps below the repo rate (25 bps prior to the pandemic) and the marginal standing facility (MSF) rate at 25 bps above the repo rate. 22Chapter I Macroeconomic Outlook seen as resilient. With inflation projected to remain Table I.2: Baseline Assumptions for Projections above the upper tolerance level of 6 per cent through Indicator MPR April 2022 MPR September 2022 the first three quarters of 2022-23, entailing the risk of destabilising inflation expectations and triggering Crude Oil US$ 100 per barrel US$ 100 per barrel during (Indian basket) during 2022-23 H2:2022-23 second round effects, the MPC was of the view that Exchange rate ` 76/US$ during 2022-23 ` 80/US$ during H2:2022-23 further calibrated monetary policy action was needed Monsoon Normal for 2022-23 7 per cent above long period to contain inflationary pressures, pull back headline average for 2022-23# inflation within the tolerance band closer to the target, Global growth 3.5 per cent in 2022 3.2 per cent in 2022 and keep inflation expectations anchored to ensure 3.5 per cent in 2023 2.9 per cent in 2023 sustained growth. Accordingly, the MPC unanimously Fiscal deficit To remain within To remain within (per cent of GDP) BE 2022-23 BE 2022-23 decided to increase the repo rate by 50 basis points Centre: 6.4 Centre: 6.4 and maintained its stance of June 2022 with a majority Combined: 9.0 Combined: 9.3 of 5 to 1. Domestic No major change No major change macroeconomic/ The MPC’s voting pattern reflects the diversity in structural policies during the individual members’ assessments, expectations and forecast period policy preferences, a characteristic also reflected in #: as on September 29, 2022. voting patterns of other central banks (Table I.1). Notes: 1. The Indian basket of crude oil represents a derived numeraire comprising sour grade (Oman and Dubai average) and sweet grade (Brent) crude oil. Macroeconomic Outlook 2. The exchange rate path assumed here is for the purpose of generating the baseline projections and does not indicate any Chapters II and III analyse macroeconomic ‘view’ on the level of the exchange rate. The Reserve Bank is developments related to inflation and economic guided by the objective of containing excess volatility in the foreign exchange market and not by any specific level of and/or activity during H1:2022-23 (April-September). The band around the exchange rate. 3. BE: Budget estimates. 4. Combined fiscal deficit refers to that of the Centre and States taken together. Table I.1: Monetary Policy Committees and Sources: RBI estimates; Budget documents; and IMF. Policy Rate Voting Patterns Country Policy Meetings: April-September 2022 evolution of key macroeconomic and financial Total Meetings Meetings Variation variables over the past six months warrants revisions meetings with full without in policy in the baseline assumptions (Table I.2). consensus full rate (basis consensus points) First, international crude oil prices have exhibited Brazil 4 3 1 200 large volatility in H1. Brent crude oil prices hardened Chile 4 3 1 375 Colombia 3 1 2 400 to US$ 121 per barrel by mid-June, driven by supply Czech Republic 3 0 3 200 concerns due to sanctions on Russia. Prices have Hungary 6 6 0 735 cooled off since then, as global demand is weakening. India 4 4 0 140 Continued supply management by the Organization Israel 4 4 0 190 Japan 4 1 3 0 of Petroleum Exporting Countries (OPEC) plus and South Africa 3 0 3 200 gas-to-oil switching due to record natural gas prices Sweden 3 3 0 175 have supported crude oil prices while the geopolitical Thailand 3 1 2 50 conflict and sanctions weigh heavily on the outlook UK 4 0 4 150 US 4 3 1 275 (Chart I.1.a & Chart I.1.b). Taking into account these Sources: Central bank websites. developments, crude prices (Indian basket) are 33Monetary Policy Report September 2022 Chart I.1: Crude Oil Prices a: Brent Prices b: World Oil Production, Consumption and Change in Stock Sources: Bloomberg; and US Energy Information Administration (EIA). assumed at US$ 100 per barrel in the baseline, same Chart I.2: Global GDP and Inflation as in the April MPR baseline. Second, the INR exhibited a depreciating bias vis-à- vis the US dollar during H1 on the back of generalised strengthening of the US dollar against currencies, elevated crude oil prices and portfolio outflows. The US dollar index strengthened by 16 per cent between end-March 2022 and September 27, reflecting aggressive monetary policy tightening by the US Fed and expectations of future hikes. Taking these developments into consideration, the exchange rate is assumed at INR 80 per US dollar in the baseline as against INR 76 in the April 2022 MPR, a depreciation of 5 per cent. Source: IMF. Third, global economic prospects have weakened significantly since the April MPR, due to multi- fell into contraction zone in August 2022 for the first pronged headwinds discussed earlier (Chart I.2). time since June 2020. Global factors exert downward Global trade is slowing down and there are increasing pressures on domestic activity and upward pressures concerns of recessions in major economies. The on domestic inflation through a variety of channels global composite Purchasing Managers Index (PMI) (Box I.1). 44Chapter I Macroeconomic Outlook Box I.1: Macroeconomic Implications of Low Global Growth and High Global Inflation Global growth is expected to slow down from 6.1 per cent demand. Third, higher global inflation and global interest in 2021 to 3.2 per cent in 2022 and the outlook is “gloomy rates impact capital flows, put downward pressures on the and more uncertain”, with risks tilted to the downside domestic currency and lead to higher imported inflation. (IMF, 2022). Global consumer price inflation is projected Based on the ‘Rest of the World (RoW) Block’ of the RBI’s by the IMF to increase from 4.7 per cent in 2021 to 8.3 per Quarterly Projection Model3, the peak impact on India’s cent in 2022. inflation and growth through all the channels occurs by These global stagflationary impulses can impact domestic four quarters. Second-round effects can keep inflation growth and inflation through multiple channels. First, at elevated levels even beyond 8 quarters, necessitating lower external demand drags down export demand and appropriate monetary policy actions to anchor inflation overall domestic demand and growth. At the same time, expectations (Chart I.1.1). In such circumstances, weak global demand can soften global commodity prices. frontloaded monetary policy actions by showing a strong Second, higher global commodity prices increase domestic commitment to the inflation target add to credibility gains inflation through direct and cost-push channels and and help in reining in inflation with lower output losses dampen domestic growth through weakening of aggregate (John, Kumar and Patra, 2022). Chart I.1.1: Global Shocks and Domestic GDP Growth and Inflation a: Growth Impact b: Inflation Impact Source: RBI staff estimates. References: Benes, J., K. Clinton, A. George, P. Gupta, J. John, O. Kamenik, D. Laxton, P. Mitra, G. Nadhanael, R. Portillo, H. Wang, and F. Zhang (2016), “Quarterly Projection Model for India: Key Elements and Properties”, RBI Working Paper Series No. 08. International Monetary Fund (2022), World Economic Outlook, July. John, J., D. Kumar, and M. D. Patra (2022), “Monetary Policy: Confronting Supply-driven Inflation”, RBI Bulletin July, Volume LXXVI (7), pp. 97-109. 3 The QPM belongs to the genre of consensus macroeconomic new Keynesian open economy structural models and is calibrated to incorporate the India- specific characteristics (Benes et al., 2016). 55Monetary Policy Report September 2022 I.2 The Outlook for Inflation Chart I.3: Inflation Expectations of Households CPI inflation has ruled at or above the upper tolerance threshold of 6 per cent since January 2022 albeit with some moderation in recent months (Chapter II). Looking ahead, the three months and one year ahead median inflation expectations of urban households increased by 50 bps each in the September 2022 round of the Reserve Bank’s survey compared to the previous round4. The proportion of respondents expecting the general price level to increase by more than the current rate also increased in both the three months and one year ahead horizons vis-à-vis the previous round (Chart I.3). Manufacturing firms polled in the July-September 2022 round of the Reserve Bank’s industrial outlook Source: Inflation Expectations Survey of Households, RBI. survey expected reduction in cost of raw materials as well as selling prices in Q3:2022-23 (Chart I.4a).5 in manufacturing and services PMI reported increase Services and infrastructure sector companies also in input and output prices in August 2022, although expected softening in input costs and selling prices with some moderation in the pace of inflationary in Q3:2022-23 (Charts I.4b and I.4c).6 The respondents pressures. Chart I.4: Expectations for Cost of Raw Materials/Inputs and Selling Prices a: Manufacturing Firms b: Services Firms c: Infrastructure Firms Source: Industrial Outlook Survey, RBI. Source: Services and Infrastructure Outlook Survey, RBI. Source: Services and Infrastructure Outlook 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. 4 The Reserve Bank’s inflation expectations survey of households is being conducted in 19 cities since March 2021 (18 cities in the previous rounds) and the results of the September 2022 round are based on responses from 6,052 households. 5 The results of the July-September 2022 round of the industrial outlook survey are based on responses from 1,234 companies. 6 Based on 469 services and 124 infrastructure companies polled in the July-September 2022 round of the services and infrastructure outlook survey. 66Chapter I Macroeconomic Outlook Professional forecasters surveyed by the Reserve Bank Table I.3: Projections - Reserve Bank and in September 2022 expected CPI inflation to soften Professional Forecasters from 7.3 per cent in Q1:2022-23, to 6.0 per cent in Q4, (Per cent) and 4.9-5.0 per cent in H1:2023-24 (Chart I.5a and Table 2022-23 2023-24 I.3).7 Long-run inflation expectations of professional Reserve Bank’s Baseline Projections Inflation, Q4 (y-o-y) 5.8 5.2 forecasters – measured by their 5- and 10-year ahead Real GDP growth 7.0 6.5 expectations – remained broadly aligned around Median Projections of Professional Forecasters the inflation target, albeit with a slight upward drift Inflation, Q4 (y-o-y) 6.0 5.0@ during the pandemic period. In the September round, Real GDP growth 7.0 6.1 Gross domestic saving (per cent of GNDI) 28.0 28.7 the 5-year ahead expected inflation rose by 10 bps Gross capital formation (per cent of GDP) 31.3 31.5 to 5.0 per cent while the 10-year ahead expectation Credit growth of scheduled commercial banks 13.0 11.0 remained unchanged at 4.5 per cent (Chart I.5b). Combined gross fiscal deficit (per cent of GDP) 9.7 9.0 Central government gross fiscal deficit (per cent of 6.4 6.0 GDP) Looking ahead, several exogenous factors – global Repo rate (end-period) 6.00 6.00@ and domestic – will impinge on the inflation outlook. Yield on 91-days treasury bills (end-period) 6.2 6.0 Global commodity prices have come off their highs Yield on 10-year central government securities 7.5 7.4 (end-period) on weaker global prospects but remain elevated Overall balance of payments (US$ billion) -57.6 -7.4 and volatile. Global supply chains are gradually Merchandise exports growth 7.2 6.3 Merchandise imports growth 19.0 5.7 normalising, although they remain vulnerable Current account balance (per cent of GDP) -3.4 -2.7 to geopolitical disturbances, pandemic-related @: Q2:2023-24 lockdowns in major production hubs, and financial Note: GNDI: Gross National Disposable Income. Sources: RBI staff estimates; and Survey of Professional Forecasters market volatility. Domestically, the record foodgrains (September 2022). Chart I.5: Inflation Expectations of Professional Forecasters a: CPI Inflation Expectations: Short-run* b: CPI Inflation Expectations: Long-run *: Five quarters ahead expectations in September 2022. Sources: Survey of Professional Forecasters, RBI; and National Statistical Office. 7 41 panellists participated in the September 2022 round of the Reserve Bank’s survey of professional forecasters. 77Monetary Policy Report September 2022 production in 2021-22, the above normal south- Chart I.6: Projection of CPI Inflation (y-o-y) west monsoon during 2022, the recovery in kharif sowing, ample buffer stocks and improved reservoir position augur well for agricultural prospects and the future trajectory of food inflation. Taking into account the initial conditions, signals from forward- looking surveys and estimates from structural and other time-series models, CPI inflation is projected to average 6.7 per cent in 2022-23 – 7.1 per cent in Q2, 6.5 per cent in Q3 and 5.8 per cent in Q4, with risks evenly balanced (Chart I.6). The 50 per cent and the 70 per cent confidence intervals for headline inflation Note: The fan chart depicts uncertainty around the baseline projection in Q4:2022-23 are 4.7-6.9 per cent and 4.0-7.6 per 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, cent, respectively. For 2023-24, assuming a normal 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 monsoon, a progressive normalisation of supply 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 chains, and no further exogenous or policy shocks, respective shaded areas. Source: RBI staff estimates. structural model estimates indicate that inflation will average 5.2 per cent. In Q4:2023-24, CPI inflation is chain disruptions with shocks getting transmitted projected at 5.2 per cent, with the 50 per cent and the through highly integrated global supply chains 70 per cent confidence intervals at 3.5-7.0 per cent (Box I.2), shortfall in kharif production, unseasonal and 2.5-7.9 per cent, respectively. rainfall and larger pass-through of input cost pressures The baseline forecasts are subject to several upside to output prices as demand strengthens. The and downside risks. The upside risks emanate from downside risks could arise from an early resolution a further ratcheting up of geopolitical tensions, of geopolitical tensions, further correction in global higher global crude and commodity prices, escalation commodity prices due to slowing global demand, in global financial market volatility due to aggressive and further improvement in supply conditions with monetary policy actions, longer-than-expected supply the ebbing of the pandemic. Box I.2: Global Cost-Push Spillovers on Inflation: Insights from World Input-Output Tables The global surge in inflation draws its origins from two Indian economy can be captured through Inter-Country large adverse shocks in quick succession – the COVID–19 Input-Output (ICIO) tables (OECD, 2021). The potential pandemic and the conflict in Ukraine – reinforced by impact of country-specific sectoral shocks is estimated demand pressures emanating from sizeable monetary- by using the Leontief Inverse Matrix to identify the fiscal stimuli. With more integrated global value chains, countries and sectors that can pose highest cost-push sectoral and country-specific shocks now transmit more inflationary risks. swiftly than ever before (de Soyres and Franco, 2020)8. The cost-push inflationary impact of global shocks on the (Contd.) 8 Intermediate goods accounted for almost half of all global trade, with trade comprising about 30 per cent of world output in 2021 (United Nations Conference on Trade and Development, 2022). 88Chapter I Macroeconomic Outlook aggregated by using CPI weights ( ). is the spillover ; ; ; from the jth country and is the spillover from the kth sector. ; The empirical analysis indicates that a global inflation L is the Leontief inverse, I is an identity matrix and A is shock of one percentage point - modelled as a the technical coefficient matrix derived from ICIO, with simultaneous one per cent increase in prices across all dimensions (J*K x J*K) – J and K are the total number the countries and sectors – could increase inflation in of economies (71) and industries (45), respectively. SHK India by around 63 bps through second round effects is the shock vector modelled as a unit shock (one per comprising domestic indirect effects (46 bps) and global cent), adjusted for the relative share of the shock size spillovers (17 bps)9, in addition to the direct impact of 100 of the sector and country of origin in the global shock. bps (Chart I.2.1). Domestic sources of inflation (direct as is a (J x K) domestic CPI inflation response matrix well as indirect) mainly stem from agriculture and allied Chart I.2.1: Global Supply Shocks: Impact on Inflation a: Response of Inflation to 1 Per cent Global Supply Shock b: Domestic Sources of Inflation: Sectors c: Global Spillovers on Inflation: Source Sectors d: Global Spillovers on Inflation: Source Countries Source: RBI staff estimates using OECD ICIO. (Contd.) 9 These estimates assume the absence of other channels of transmission like exchange rate and inflation expectations and no offsetting macroeconomic policy actions. 99Monetary Policy Report September 2022 activities, housing, textiles, and pharmaceutical sectors. on domestic inflation over time through the cost-push Global spillovers, representing the imported inflation channel. channel, are driven by price pressures in energy, mining, References: chemicals, trade, basic metals and machinery. In terms de Soyres, F. and S. Franco. (2019), “Inflation Dynamics of source countries, the most important contributors to and Global Value Chains”, World Bank Policy Research inflation in India are oil exporting countries, China and Working Paper No. 9090. the United States. UNCTAD (2022), “The Effects of the COVID-19 Pandemic The current bout of global inflation is mainly driven on International Trade”, Key Statistics and Trends in by the jump in global energy and agricultural product International Trade 2021, https://unctad.org/system/files/ prices (which rose by almost 40 per cent and 10 per official-document/ditctab2022d3_en.pdf cent, respectively, during H2:2021-22). The empirical analysis suggests that the global food and energy shocks OECD (2021), Inter-Country Input-Output Tables, experienced during H2:2021-22 could ceteris paribus available at https://www.oecd.org/sti/ind/inter-country- impart upward pressure of around 2.5 percentage points input-outputtables.htm I.3 The Outlook for Growth though overall confidence remained in the pessimistic zone. Households remained optimistic Ebbing COVID-19 infections and improving consumer for the year ahead, with the future expectations sentiment facilitated a rebound in demand for index remaining unchanged vis-à-vis the July 2022 contact-intensive services and supported domestic survey round (Chart I.7).10 demand in H1:2022-23. Industry and services sectors are holding up well and kharif sowing has seen a smart recovery. The above-normal south- Chart I.7: Consumer Confidence west monsoon has improved reservoir levels which bodes well for the winter crops. Investment activity is expected to benefit from the government’s capex push, growth in bank credit, improving demand conditions and rising capacity utilisation. Geopolitical tensions, the upsurge in global financial market volatility and tightening global financial conditions, however, weigh heavily on the outlook. Turning to the key messages from forward-looking surveys, consumer confidence (the current situation index) increased further in the September 2022 survey round on account of improved perception Source: Consumer Confidence Survey, RBI. on general economic situation and overall spending, 10 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 September 2022 round are based on responses from 6,062 respondents. 1100Chapter I Macroeconomic Outlook 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 Survey, RBI. Source: Services and Infrastructure Outlook Survey, RBI. Optimism on demand conditions in the broadly balanced around this baseline path (Chart manufacturing sector for the quarter ahead waned I.10 and Table I.3). For 2023-24, assuming a normal marginally in the July-September 2022 round of the monsoon, and no major exogenous or policy shocks, Reserve Bank’s industrial outlook survey, though the structural model estimates indicate real GDP it remained well in the expansion zone (Chart growth at 6.5 per cent. I.8a). Services sector companies expected slight There are upside and downside risks to the baseline moderation while infrastructure companies expected growth path. Upside risks to the baseline trajectory a minor uptick in Q3:2022-23 in terms of the overall business situation (Charts I.8b and I.8c). Table I.4: Business Expectations Surveys Recent surveys by other agencies indicate a dip in Item NCAER FICCI Dun and CII business expectations over their respective previous Business Overall Bradstreet Business rounds (Table I.4). In the August 2022 round of the Confidence Business Composite Confidence PMI survey, business expectations of manufacturing Index (July Confidence Business Index 2022) Index Optimism (September and services firms improved to multi-year highs on (August Index 2022) optimism over strengthening demand. 2022) (September 2022) Professional forecasters polled in the September 2022 Current level of 138.5 65.0 69.9 62.2 round of the Reserve Bank’s survey expected real GDP the index growth at 6.3 per cent in Q2:2022-23, 4.8 per cent in Index as per the 142.9 67.6 96.6 66.9 previous survey Q3 and 4.2 per cent in Q4, and at 6.4-6.6 per cent in % change (q-o-q) -3.1 -3.8 -27.6 -7.0 H1:2023-24 (Chart I.9 and Table I.3). sequential % change (y-o-y) 124.1 -8.8 -5.8 -0.6 Taking into account the baseline assumptions, survey Notes: 1. NCAER: National Council of Applied Economic Research. indicators and model forecasts, real GDP growth is 2. FICCI: Federation of Indian Chambers of Commerce & Industry. expected at 7.0 per cent in 2022-23 – 6.3 per cent in 3. CII: Confederation of Indian Industry. Sources: NCAER; FICCI; CII; and Dun & Bradstreet Information Services Q2; and 4.6 per cent each in Q3 and Q4 – with risks India Pvt. Ltd. 1111Monetary Policy Report September 2022 Chart I.9: Professional Forecasters' Projection of Chart I.10: Quarterly Projection of Real GDP Real GDP Growth Growth (y-o-y) 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. could emanate from stronger-than-expected alternative scenarios to assess the balance of risks expansion in demand for contact-intensive services around the baseline projections. with the receding threat of the pandemic and festival (i) Global Growth Uncertainties spending; a boost to private investment activity from The downside risks to global growth flagged in government’s capex push, improving bank credit, the April 2022 MPR have materialised. Headwinds rising capacity utilisation, and healthier corporate from the war, elevated commodity prices, tightening balance sheets; and a favourable terms of trade financial conditions, capital outflows from shock in the case of a sharp correction in crude and emerging economies, and the slowing global commodity prices. On the contrary, an escalation activities could pull global growth further below the in geopolitical tensions, further hardening of baseline. There are growing concerns of recession in international crude oil and other commodity prices, major economies and the global outlook is bleak and sustained disruptions to supply chains, the upsurge risks are tilted to the downside. In such a scenario, in global financial market volatility, and a sharper if global growth is 100 bps below the baseline, loss of momentum in global trade and demand pose domestic growth and inflation could be around 40 downside risks to the baseline growth path. bps and 20 bps, respectively, below the baseline I.4 Balance of Risks trajectories. Conversely, if there is an early de- Baseline projections of inflation and growth are escalation in geopolitical tensions, the recent trend conditional on assumptions of the future course of key in falling commodity prices continues, and global domestic and international macroeconomic variables inflation ebbs faster than expected, there can be a set out in Table I.2. There are, however, sizeable fillip to global growth. In this scenario, assuming uncertainties around the baseline assumptions, that global growth surprises by 50 bps on the upside, as stated earlier. This section explores plausible domestic growth and inflation could edge higher by 1122Chapter I Macroeconomic Outlook Chart 1.11: 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. around 20 bps and 10 bps, respectively (Charts I.11a (iii) Exchange Rate and I.12a). The INR depreciated in H1, driven by the generalised (ii) International Crude Oil Prices strengthening of the US dollar, higher crude oil prices and sales by foreign portfolio investors. Volatility in Global crude oil prices remain at elevated levels, global financial markets is expected to persist due to driven by geopolitical tensions, sanctions and supply the uncertainty around monetary policy normalisation management by OPEC plus. Further production in the US and other major advanced economies, which curtailment by OPEC plus and the spike in the could put downward pressure on the INR. Should seasonal winter demand for energy amidst high the INR depreciate by 5 per cent from the baseline, natural gas prices could harden international crude oil inflation could edge up by around 20 bps while GDP prices. Assuming crude oil prices (Indian basket) to be growth could be higher by around 15 bps through 10 per cent above the baseline of US$ 100 per barrel, boost to exports. On the other hand, given India’s domestic inflation and growth could be higher by 30 relatively better growth performance and outlook bps and weaker by around 20 bps, respectively, over and strong domestic macroeconomic fundamentals, the baseline. Conversely, crude oil prices could soften portfolio equity flows turned significantly positive below the baseline owing to global demand losing in August 2022 and could increase further. In this momentum and an easing of geopolitical tensions. As scenario, if the INR appreciates by 5 per cent relative a result, if the Indian basket of crude prices falls by 10 to the baseline, inflation and GDP growth could per cent relative to the baseline, inflation could ease moderate by around 20 bps and 15 bps, respectively by around 30 bps with a boost of 20 bps to growth (Charts I.11b and I.12b). (Charts I.11a and I.12a). 1133Monetary Policy Report September 2022 Chart 1.12: 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. (iv) Food Inflation food prices and headline inflation could be around 50 bps above the baseline (Charts I.11b and I.12b). Food inflation remained high during H1, driven by I.5 Conclusion the war-induced jump in global food prices. Global food prices have started correcting and these are The Indian economy is advancing steadily, and is being reflected in the softening of domestic edible expected to be one of the fastest growing major oil prices. Furthermore, kharif sowing has caught economies in 2022. The above-normal south-west up with its long-term average. Reservoir levels are monsoon, improved reservoir position, government’s above last year’s and the decadal average, which capex push, improvement in capacity utilisation, a augur well for the rabi crop. Although the area under broad-based revival in credit growth, strong corporate paddy sowing has been lower than a year ago due and bank balance sheets, upbeat consumer and to uneven distribution of south-west monsoon business confidence and receding threat of the rainfall, ample buffer stocks of rice and effective pandemic are all factors likely to provide impetus to supply management measures could soften food growth. While inflation has eased somewhat from the inflation more than anticipated, and push headline April high, supported by some correction in global inflation 50 bps below the baseline. Conversely, prices, it has ruled above the upper tolerance threshold global food prices could harden in view of the fragile around the target since January 2022. Monetary policy geopolitical outlook and sustained input price has moved into the withdrawal of accommodation pressures on critical inputs like energy and fertilisers. mode and remains focussed to ensure that inflation Furthermore, unseasonal heavy rainfalls during the returns to the target while supporting growth. The harvesting period could impact the domestic crop. In daunting global environment, however, imparts such a scenario, there could be upward pressures on considerable uncertainty to the outlook. 1144II. Prices and Costs The trajectory of consumer price index (CPI) inflation since February 2022 has been altered by spillovers from the conflict in Ukraine. CPI inflation peaked in April 2022 and has since then moderated but persists above the pre-war levels and also above the upper tolerance band. During H1:2022-23, industrial and farm input pressures remained firm, notwithstanding some softening. Nominal rural wage growth was muted. Since February 2022, the trajectory of headline CPI bottlenecks, sanctions and second-round effects. inflation1 has been altered by spillovers from adverse Global financial market volatility engendered by global commodity price shocks triggered by the aggressive monetary tightening and consequent conflict in Ukraine. In February, it was anticipated spillovers to domestic financial markets exacerbated that the pandemic-induced global supply chain inflationary pressures. disruptions would ease with the ebbing of COVID-19 Headline CPI inflation was already testing the upper infections, the combination of domestic supply side tolerance threshold of 6 per cent during January- measures and a normal monsoon would bring about February 2022, due to adverse base effects, and a a durable softening of domestic inflation over the sticky core component.2 Starting March, the fallout course of the year. The war upended this narrative of the adverse global commodity price shocks spread with a broad-based spike in global commodity across items. In April, the heat wave and consequent prices, the resurgence of supply chain and logistics production losses added to a sharp pick-up in prices. 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 (y-o-y) 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. 1155Monetary Policy Report September 2022 As a result, headline inflation surged by 173 basis Chart II.2: CPI Inflation (y-o-y): points in two months – from 6.1 per cent in February Projection versus Actual to 7.8 per cent in April across food, fuel and core components. Judicious supply side interventions by the government and some softening of global commodity prices from their peak March 2022 levels enabled inflation to moderate to 6.7 per cent in July before it edged up to 7.0 per cent in August on a surge in food inflation (Chart II.1). The Reserve Bank of India (RBI) Act enjoins the RBI to set out deviations of actual inflation outcomes from projections, if any, and explain the underlying reasons thereof. The April 2022 MPR projected inflation at 6.3 per cent for Q1:2022- *: Projections for entire Q2:2022-23 vis-a-vis actual average inflation during July-August 2022. 23 and 5.8 per cent for Q2. War-induced price Sources: NSO; and RBI staff estimates. pressures as well as domestic supply shocks turned out to be stronger and more persistent than anticipated, resulting in actual inflation exceeding also contributed to projection errors, partly offset projections by around 100 bps each in Q1 and by the cut in excise duties on petrol and diesel in Q2 (July-August) (Chart II.2). This came about May 2022. largely from substantial upward surprises in food II.1 Consumer Prices inflation.3 The unprecedented increase in global As explained in the preceding section, the surge food prices in March led to sharp increases in in headline inflation in April was sharp and broad- domestic prices of edible oils, animal-based proteins through high feed costs, and wheat through export based. Thereafter, a deceleration of the momentum linkages. At the same time, the adverse impact of the of prices, supported by a large favourable base effect, intense heat wave caused damage to the rabi wheat brought down inflation to 7.0 per cent in May-June.4 crop, and tomato prices jumped by 158.4 per cent (on The deceleration in momentum in May was located in a year-on-year basis) in June 2022. Processed food the core component, even as food price momentum prices also registered increases as higher input costs remained robust. In June, headline momentum were passed on to selling prices. The depreciation moderated further, across all major groups. In July, of the Indian rupee from the baseline of `76 per even as headline CPI momentum remained unchanged US$ to around `79-80 per US$ by August-September at June level, favourable base effect led to a softening 3 The April 2022 MPR had largely accounted for the persistence of international crude prices at elevated levels during 2022-23, with an assumption of US$ 100 per barrel. 4 A change in CPI 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. 1166Chapter 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. in inflation by 30 bps to 6.7 per cent. August was the Chart II.4: Average CPI Inflation (y-o-y) third successive month with a steady momentum of (Kernel Density Estimates) 0.5 per cent; inflation, however, edged up by around 30 basis points as the favourable base effects waned (Chart II.3). The mean of the CPI inflation distribution rose to 6.8 per cent in 2022 (January-August) from 5.3 per cent during the corresponding period in 2021 and the pre-COVID average of 3.4 per cent for 2017-19 (January-August). This was accompanied by higher median rates and lower dispersion in the sub- group/group-wise distribution of inflation rates signifying generalisation of inflation (Chart II.4), and heightened uncertainty about future inflation Sources: NSO; and RBI staff estimates. (Box II.1). 1177Monetary Policy Report September 2022 Box II.1: Inflation and Inflation Uncertainty in India Sustained high inflation can lead to higher uncertainty volatility) is estimated by employing a generalized and allocative inefficiency (Friedman, 1977; Ball, 1992). autoregressive conditional heteroskedasticity (GARCH) The impact of inflation variability can, however, be model. Three specifications are estimated to address the ambiguous, depending on whether the central bank various hypotheses using GARCH (2,1)5 estimates. Model I tolerates higher inflation (Cukierman and Meltzer, 1986) is the baseline model; in Model II, inflation rate is added or it is committed to the inflation target and adopts a to assess the Friedman-Ball hypothesis; in Model III, contractionary policy (Holland, 1995). uncertainty (i.e., the variance of inflation) is included in the mean equation to explore the Cukierman–Meltzer/ Using CPI data (month-on-month percentage changes Holland hypothesis (Table II.1.1). of seasonally adjusted data) for the period April 2005 to July 2022, time-varying inflation uncertainty (or inflation The sum of ARCH and GARCH coefficients is in the range of 0.83 to 0.96 (i.e., less than 1), suggesting that inflation volatility exhibits high degree of persistence but is mean Table II.1.1: Inflation and Inflation Volatility: reverting (Chart II.1.1). Estimates of GARCH Models The level of inflation is seen to have a positive impact Variable Model I Model II Model III on the variance of inflation (Model II), providing support Mean Equation for the Friedman-Ball hypothesis. Inflation volatility is Constant 0.46*** 0.32*** -0.37*** (0.05) (0.04) (0.14) seen to have a negative impact on the rate of inflation Inflation (-1) 0.22*** 0.27** 0.25*** in line with the Holland hypothesis (Model III). Granger (0.06) (0.06) (0.06) Log(GARCH) - - -0.50*** causality analysis indicates causality running from (0.07) inflation to inflation volatility (Table II.1.2). Overall, the Variance Equation analysis suggests that high levels of inflation can raise Constant 0.04 -0.01 0.01* uncertainty about future inflation and impinge upon (0.03) (0.01) (0.01) ARCH(-1) 0.25*** 0.15** 0.47*** inflation expectations, stressing the need for keeping (0.09) (0.07) (0.10) inflation around the target. ARCH(-2) -0.23*** -0.15** -0.45*** (0.08) (0.06) (0.10) GARCH(-1) 0.83*** 0.82*** 0.94*** (0.18) (0.06) (0.03) Inflation - 0.09*** - Chart II.1.1: Conditional Standard Deviation of (0.02) Inflation based on GARCH (2,1) Diagnostics ARCH-LM (3) 0.43 1.58 0.46 (0.73) (0.20) (0.71) ARCH-LM (6) 0.61 0.94 0.82 (0.72) (0.47) (0.55) Q2(3) 1.41 4.20 1.39 (0.77) (0.24) (0.71) Q2(6) 3.21 6.01 4.85 (0.78) (0.42) (0.56) Engle-Ng Sign-Bias Test 2.20 4.34 2.69 (0.53) (0.23) (0.44) Note: ***, ** and * indicate significance at 1, 5 and 10 per cent levels, respectively. Figures in parentheses indicate standard errors for mean and variance equations and p-values for the diagnostic tests. Inflation has been calculated as the seasonally adjusted month-over-month increase in prices. Note: For April and May 2020, imputed indices released by NSO have been used. The sample period for the analysis is April 2005-July 2022. Source: RBI staff estimates. Source: RBI staff estimates. (Contd.) 5 A conditional least square estimation of the ARMA (1,1) model confirms that there are significant ARCH effects. 1188Chapter II Prices and Costs Ball, L. (1992), “Why does High Inflation Raise Inflation Table II.1.2: Causality between Inflation and Uncertainty?”, Journal of Monetary Economics, 29(3), 371- Inflation Volatility 388. Null Hypothesis Lag 3 Lag 6 Cukierman, A., & Meltzer, A. H. (1986), “A Theory of Inflation does not Granger cause Inflation Volatility 6.75*** 3.54*** Ambiguity, Credibility, and Inflation under Discretion and Inflation Volatility does not Granger cause Inflation 1.90 1.02 Asymmetric Information”, Econometrica, 54(5), 1099-1128. Note: *** indicates significance at 1 per cent level. Holland, A. S. (1995), “Inflation and Uncertainty: Tests Source: RBI staff estimates. for Temporal Ordering”, Journal of Money, Credit and Banking, 27(3), 827-837. References: Balaji, B., Durai, S., & Ramachandran, M. (2016). “The Friedman, M. (1977), “Nobel Lecture: Inflation and Dynamics between Inflation and Inflation Uncertainty: Unemployment”, Journal of Political Economy, 85(3), 451- Evidence from India”, Journal of Quantitative Economics, 472. 14(1), 1-14. Diffusion indices (DIs)6 also attest to generalised annualised rate (saar). Though there was some let price increases across the CPI basket during March- up during May-June, the spread of price increases April 2022 (Chart II.5a). A majority of the items in the accelerated during July-August. In August, a majority CPI basket showed threshold DIs7 in excess of 4 per of CPI basket registered prices increases in excess of cent and 6 per cent, based on a seasonally adjusted 4 per cent (saar) (Chart II.5b). Chart II.5: CPI Diffusion Indices (M-o-M Seasonally Adjusted) a: CPI Headline, Goods and Services b: CPI Headline by Thresholds 100 90 80 70 60 50 40 30 20 10 0 Sources: NSO; and RBI staff estimates. 6 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. The higher the reading is above 50 for the diffusion index, the broader is the expansion or generalisation of price increases; the further is the reading below 50, the broader is the price decline across items. 7 Threshold diffusion indices capture the dispersion of price increases in CPI basket beyond the specified saar thresholds of 4 per cent and 6 per cent. 1199 xednI 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 22-rpA 22-nuJ 22-guA 100 90 80 70 60 50 40 30 20 10 0 CPI Headline CPI goods CPI services xednI 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 22-rpA 22-nuJ 22-guA Morethan4per cent Morethanorequalto 6percentMonetary Policy Report September 2022 II.2 Drivers of Inflation along with fuel price shocks, while aggregate demand conditions continued to exert downward pressure on A historical decomposition of inflation using vector inflation (Chart II.6a). autoregression (VAR)8 analysis to ascertain the relative role of various macro factors indicates that the rise During March-August 2022, goods inflation in inflation during H1:2022-23 can be primarily contributed 86 per cent of headline inflation. attributed to adverse supply-side shocks from food Perishables (non-durable goods with a 7-day Chart II.6: Drivers of CPI Inflation a: Decomposition of CPI Inflation* * Deviation from deterministic trend. Note: Estimated using a vector autoregression (see footnote 8 for details). Sources: NSO; RBI; Petroleum Planning & Analysis Cell (PPAC); BSE; Labour Bureau; and RBI staff estimates. 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 8 Historical decomposition estimates the contribution of each shock to the movements in inflation over the sample period (Q4:2010-11 to Q2-2022-23) based on a vector autoregression (VAR) with the following variables (represented as the vector Y) – crude oil prices (US$ per barrel); exchange rate (INR t per US$), asset price (BSE Sensex), CPI; the output gap; rural wages; the policy repo rate; and money supply (M). All variables other than policy repo rate 3 are y-o-y growth rates. The VAR can be written in reduced form as: Y =c + A Y + e; where e represents a vector of shocks. Using Wold decomposition, t t-1 t t Y can be represented as a function of its deterministic trend and sum of all the shocks e. This formulation facilitates decomposition of the deviation of t t inflation from its deterministic trend into the sum of contributions from various shocks. 2200Chapter II Prices and Costs recall9) like milk, tomatoes, potatoes, edible oils, decline in international commodity prices in July- cooked meals and chicken as well as semi-perishable August 2022 lowered imported inflation. The cut in goods (non-durable goods with a 30-day recall), central excise duties on petrol and diesel in May 2022 particularly, petroleum products like kerosene, reduced domestically generated inflation (Chart II.6c). liquified petroleum gas (LPG) and petrol along with Food cereals and medicines were the main drivers of goods Food and beverages (with a weight of 45.9 per cent in inflation (Char t II.6b). Durable goods contributed CPI) inflation rose to 8.1 per cent in April 2022, owing to 12.8 per cent of overall inflation. The contribution of global supply shortages and adverse domestic weather services (with a weight of 23.4 per cent in overall CPI) conditions. Thereafter, food inflation eased to 6.7 per remained muted at around 14 per cent of headline cent in July, supported by the Government’s supply- inflation (Chart II.6b). side measures, some easing of international food The increase in global commodity prices following prices and a substantial correction in tomato prices. the conflict in Ukraine contributed to a surge in the In August, food inflation turned around to register a contribution of imported components10 to headline substantial pick-up, with cereals and vegetables being inflation during March-June 2022. Subsequently, the its key drivers (Chart II.7a and II.7b). Chart II.7: CPI Food Inflation a: Drivers of CPI Food Inflation b: Drivers of CPI Food Momentum *: Includes meat & 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. 9 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 expenditures 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. 10 Global commodities that drive domestic prices include petroleum products; coal; electronic goods; gold; silver; chemical products; metal products; textiles; cereals; milk products, and vegetables oils – these together have a weight of 36.4 per cent in the CPI basket. 2211Monetary Policy Report September 2022 Chart II.8: Financial Year Price Build-up (August over March) Note: Figures in parentheses indicate weights in CPI - food and beverages. Sources: NSO and RBI staff estimates. Even as food inflation remained elevated, the food elevated global prices due to the war, higher exports price build-up in the current financial year (August (157 per cent y-o-y during April-July 2022), and decline over March) so far was muted relative to historical in stocks (0.9 times the buffer norms as on September patterns. First, food prices registered a sharp pick-up 1, 2022). In response, restrictions on wheat exports in March 2022 itself, primarily on account of meat and were imposed since May 2022, and exports of wheat fish, and edible oils. Second, while the price build-up flour were banned from August 27, 2022. Rice prices in cereals (which constitutes more than a fifth of the increased due to the substitution of wheat by rice food basket) was higher than its long-term average as under Pradhan Mantri Garib Kalyan Anna Yojana was those of fruits, spices, prepared meals and milk, these were offset by a substantial correction Chart II.9: CPI-Cereals and Products in edible oils, and meat and fish prices from historic (Cumulative Momentum) highs in May and June. Third, the summer seasonal increase in vegetable prices was lower than usual due to a softer build-up in onion, garlic and some other vegetables prices in view of higher production (Chart II.8). Inflation in the prices of cereals (weight of 9.7 per cent in the CPI and 21.1 per cent in the food and beverages group) rose from 5.0 per cent in March 2022 to 9.6 per cent in August driven by sharp pick up in momentum (Chart II.9). Within cereals, wheat prices have increased sharply since March on account of lower domestic production ((-) 2.5 per cent in 2021-22) due to heat waves in major wheat producing states, Sources: NSO; and RBI staff estimates. 2222Chapter II Prices and Costs (PMGKAY) for May-September 2022, higher exports (LMT) in 2022-23). Subsequently, prices rose during (9.0 per cent y-o-y during April-July 2022), and a fall June-August 2022 in line with the usual seasonal in area under kharif sowing and expected lower pattern. Potato prices increased during March-August production. Large stocks of rice (2.6 times the buffer 2022 due to lower production ((-) 4.6 per cent in 2021- norm as of September 1, 2022) and restrictions on 22). To rein in price pressures, free imports of potatoes broken rice exports along with imposition of 20 per were allowed from Bhutan until June 30, 2023. Tomato cent export duty on rice other than basmati and par- prices picked up dramatically during April-June 2022 boiled rice are expected to withhold undue price due to the decline in production ((-) 4.0 per cent in pressures. 2021-22) coming from lower area sown, heat waves in north India and excess rains and cyclone in Karnataka. Vegetable prices (weight of 6.0 per cent in the CPI The upbeat production response to elevated prices and 13.2 per cent in the food and beverages group) led to robust mandi arrivals and the easing of tomato inflation remained in double digits during March- prices during July-August 2022. August 2022, peaking in May. The spike in tomato prices (113.5 per cent during April-June 2022), along Inflation in prices of fruits (weight of 2.9 per cent in with price increases in other vegetables reflecting the CPI and 6.3 per cent within the food and beverages the usual summer uptick, remained the main drivers group) increased from 2.5 per cent in March 2022 to (Chart II.10). The negative contribution of onions and 7.4 per cent in August due to higher prices of bananas, garlic, on an average, during April-August partly offset apples, grapes and dry fruits. A spike in mango prices the inflationary pressures. in April 2022 due to crop damage caused by heat waves and unseasonal rains also contributed to fruit Among key vegetables, onion prices moderated during price momentum. March-May 2022 on account of higher production (an increase of 19 per cent in 2021-22) and record Pulses (plant-based protein) price inflation (weight of procurement (buffer stock of 2.5 lakh metric tonnes 2.4 per cent in the CPI and 5.2 per cent in the food and Chart II.10: Drivers of Vegetable Inflation (y-o-y) Notes: Figures in parentheses indicate items' weights in CPI-vegetables. Item level data were not released by NSO for the months of March, April and May 2020. Source: NSO; and RBI staff estimates. 2233Monetary Policy Report September 2022 Chart II.11: Pulses Inflation and Stock-Use Ratio: Monthly Balance Sheet Sources: MOSPI; DGCIS; CACP; Ministry of Agriculture; and RBI staff estimates. beverages group) moderated from March 2022 until II.12). In the case of meat and fish, prices rose during June after which it picked up during July-August. Prices March-June 2022, reflecting feed cost pressures moderated in Q1:2022-23 in line with supply side amidst the early onset of summer, accompanied by measures by the government, including the extension heat waves. Price pressures eased in July-August of tur and urad imports under the ‘free category’ 2022 due to reduced seasonal demand (on account until March 31, 2023; the reduction in Agriculture of Sravana month) and imports of genetically Infrastructure and Development Cess (AIDC) on modified (GM) soymeal. In contrast, a fall in prices lentils to 0 per cent from 10 per cent extended till along with favourable base effects dragged eggs price March 31, 2023; and higher production (8.8 per cent into deflation during April-August 2022. Milk and in 2021-22). However, inflation in pulses picked up products prices increased consistently during March- gently during July-August, driven by shortfall in kharif August 2022, as major milk cooperatives (like Amul sowing and the expected shortfall in production of and Mother Dairy) raised retail prices by `2 per litre tur and urad. Adverse base effects also contributed to each in March and August 2022, citing an increase in the pick up in pulses inflation. The higher stock-to-use input costs. This was followed by price increases by (STU) ratio (Chart II.11), aggressive procurement for other state cooperatives. central pool and supply-side interventions – like open Inflation in prices of oils and fats (weight of 3.6 per market operations along with the decision to release chana dal at a discount to states and union territories cent in the CPI and 7.8 per cent within the food and (UTs) for welfare schemes – are, however, expected to beverages group) eased during H1:2022-23, reaching contain pressures in pulses price in H2. 4.6 per cent in August, after remaining in double digits for more than two years (Chart II.13). The Regarding animal-based protein items, prices moderation in inflation was supported by easing increased sharply in H1:2022-23, driven by meat and fish (weight of 3.6 per cent in the CPI and 7.9 per cent global prices, supply-side measures undertaken by within the food and beverages group) and milk and the government and higher domestic production products (weight of 6.6 per cent in the CPI and 14.4 (4.9 per cent in 2021-22). Global prices of edible oils, per cent within the food and beverages group) (Chart which had surged in March with the onset of the war, 2244Chapter II Prices and Costs by the government, including an extension of stock Chart II.12: Drivers of Animal Protein Prices limits on edible oils and oilseeds up to December (H1:2022-23 over H2:2021-22) 31, 2022, the reduction in basic customs duty (BCD) to 0 per cent till March 31, 2023, allocation of tariff rate quota (TRQ) import of 2.0 million tonnes each for crude soybean and sunflower oil for the financial year 2022-23 and 2023-24 at 0 per cent BCD and AIDC and hike in minimum support prices (MSPs) of kharif oilseeds for 2022-23 (5.4 per cent to 8.9 per cent increase). On the other hand, rising milk prices resulted in upside pressures in ghee and butter prices. Prices of sugar and confectionery (weight of 1.4 per cent in the CPI and 3.0 per cent in the food and Notes: Figure in parentheses indicate weight in CPI-animal protein group. H1:2022-23 refers to April-August. beverages group) remained muted during March-July Sources: NSO and RBI staff estimates. 2022 on the back of higher production (7.7 per cent corrected with the lifting of the export ban (imposed increase in sugarcane production in 2022-23) and on April 28, 2022) effective from May 23, 2022, the export restrictions on sugar effective from June 1, removal of export levy until August 31, 2022, and 2022 to ensure ample domestic supplies. However, the reduction in export duties by Indonesia. Price prices increased in August 2022 on higher exports pressures also abated due to the supply side steps (which rose by 32.5 per cent y-o-y during April-July 2022) coming from a relaxation of export limits and Chart II.13: Movement in Edible Oil Prices: from expectations of a healthy festive demand. Global vs Domestic Among other food items, inflation in prices of spices remained in double digits during H1:2022-23, reflecting lower production ((-) 1.9 per cent in 2021- 22), especially in the case of key spices like coriander, cumin, black pepper and red chillies. Furthermore, prepared meals witnessed a rise in prices, due to an increase in input costs such as edible oils, LPG and transport charges. Retail Margins Retail price margins – the difference of retail and wholesale prices11 – for cereals and pulses, which had been on the rise since the outbreak of the COVID-19 Sources: World Bank Pink Sheet; NSO; and RBI staff estimates. pandemic, remained at elevated levels during H1. 11 Item level retail and wholesale prices are aggregated at respective subgroups using item level CPI weights. Data for January-March 2021 have been excluded due to changes in price collection mechanism and item varieties (DCA). 2255Monetary Policy Report September 2022 Chart II.14: Retail and Wholesale Prices and Margins a: Cereals b: Pulses c: Vegetables d: Edible Oils (packed) Sources: Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution; and RBI staff estimates. Margins in edible oils moderated somewhat in April prices. Electricity prices have remained in deflation 2022 due to a higher degree of softening in retail in 2022 so far (Chart II.15). mustard oil prices relative to wholesale prices. In the Core case of vegetables, margins rose in May-June 2022, driven by the sharp uptick in tomato retail prices, but Core inflation, i.e., CPI inflation excluding food and they moderated subsequently with the correction in fuel, increased sharply after the start of the war tomato prices (Chart II.14). to 7.1 per cent in April 2022 from 5.8 per cent in February. It moderated thereafter on favourable base Fuel effects, the reduction in excise duties on petrol and CPI fuel inflation surged from 7.5 per cent in March diesel and some deceleration in price momentum. 2022 to 11.8 per cent by July 2022 on the back of During June-August, core inflation remained steady sharp increases in LPG and subsidised kerosene at around 6.0 per cent, including when other volatile (PDS) prices which, in turn, reflected the sharp items such as petrol, diesel, gold and silver are jump in global energy prices following the conflict excluded (Table II.1). in Ukraine. Fuel inflation moderated to 10.8 per cent in August due to decline in kerosene (PDS) prices Core inflation has been persistent and elevated reflecting pass through of the fall in international since 2021, due to repeated cost-push shocks in 2266Chapter II Prices and Costs Chart II.15: CPI Fuel Group Inflation a: Fuel Prices (y-o-y) 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 indicative international price for kerosene is the Singapore Jet Kero spot price. (2) 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. (3) The domestic prices of LPG and kerosene represent the average prices of four and three metros, respectively, as reported by Indian Oil Corporation Limited (IOCL). Domestic prices of LPG are monthly average prices. Sources: NSO; Bloomberg; IOCL; and RBI staff estimates. manufacturing and services (Chart II.16). During Table II.1: Exclusion-based Measures of Core 2022-23 (April-August), core inflation averaged 6.2 per Inflation (y-o-y) cent (5.9 per cent a year ago), with pressures broad- Month CPI excluding CPI excluding CPI excluding food food and fuel food fuel petrol fuel petrol diesel based, particularly in the goods component (Chart II.17). (47.3) diesel (45.0) gold silver (43.8) Jun-21 6.1 5.3 5.4 The jump in core inflation by 126 basis points between Sep-21 5.9 5.2 5.6 February and April 2022 was considerably influenced Dec-21 6.1 5.6 5.9 Jan-22 6.0 5.6 5.8 by spillovers from the increases in international crude Feb-22 5.8 5.6 5.7 oil and gold prices following the start of the war in Mar-22 6.4 6.2 6.1 end-February. As international crude oil prices inched Apr-22 7.1 6.5 6.4 May-22 5.9 5.5 5.5 upwards of US$ 120 per barrel in March, domestic Jun-22 6.0 6.1 6.1 petrol and diesel pump prices rose by around `10 per Jul-22 6.0 6.3 6.4 Aug-22 5.9 6.2 6.2 litre between March 22 and April 6, 2022 and then Notes: (1) Figures in parentheses indicate weights in CPI. remained unchanged till May 22, 2022. Pump prices (2) Derived as residual from headline CPI. then fell, following the reduction in excise duties Sources: NSO; and RBI staff estimates. 2277Monetary Policy Report September 2022 Chart II.16: CPI Inflation excluding Chart II.17: Contribution to CPI excluding Food Food and Fuel: Persistence Fuel (Core) Inflation (in percentage points) 4.8 CPIexcludingfoodfuel (y-o-y, percent) 6.0 6.2 ofwhich 0.6 Transportandcommunication(18.2) 1.7 1.3 0.7 Health(12.5) 1.0 0.7 0.5 Clothingandfootwear(13.8) 1.0 1.3 1.3 Housing(21.3) 0.8 0.8 0.3 Householdgoodsandservices(8.0) 0.4 0.6 0.4 Personalcareandeffects(8.2) 0.4 0.6 0.5 Education(9.4) 0.3 0.4 Others*(8.6) 0 0.5 .5 0.4 Memo Coregoods(51.3) 2.1 3.7 3.6 2.7 Coreservices(48.7) 2.3 2.6 Average(2017-18 to2019-20) 2021-22 2022-23(Apr-Aug) * Others include Pan, tobacco and intoxicants; and Recreation and amusement. Note: Figures in parentheses indicate weights in CPI excluding food and fuel. Sources: NSO; and RBI staff estimates. Sources: NSO; and RBI staff estimates. by `8 per litre on petrol and by `6 per litre on diesel Coupled with favourable base effects, the cut in (Chart II.18). excise duties resulted in CPI petrol and diesel Chart II.18: Price Build-Up (IOCL Delhi Prices) a: Petrol b: Diesel Sources: IOCL; PPAC; and RBI staff estimates. 2288Chapter II Prices and Costs Chart II.19: Petrol and Diesel Inflation (y-o-y) Chart II.20: CPI excluding Food, Fuel, Petrol, Diesel, Gold and Silver: SAAR Diffusion Index by Thresholds Sources: NSO; Ministry of Commerce and Industry; and RBI staff estimates. Sources: NSO; and RBI staff estimates. prices moving to the deflationary zone by August inflation remained significantly higher than core 2022. Price increases in WPI petrol and diesel were services inflation. Inflation in the goods component higher at 53 per cent (y-o-y) in August, largely (with a weight of 20.7 per cent in the headline CPI) reflecting the fact that indirect taxes are included increased from 7.1 per cent in February 2022 to 7.7 in CPI but excluded from WPI (Chart II.19). On the per cent in April, driven by clothing and footwear whole, the reduction in excise duties had a direct items, household goods and personal care items softening impact of 43 bps on core inflation and 20 (including fast-moving consumer goods (FMCGs) and household utensils) along with health, transport and bps on headline inflation. The decline in gold prices communications goods. Though core goods inflation during May-July also contributed to the moderation moderated to 6.5 per cent in May, the respite was of core inflation. short-lived as it edged up by around 72 bps during Threshold diffusion indices for CPI excluding food, June-August, coming mainly from a further rise in fuel, petrol, diesel, gold and silver indicate that a inflation in clothing and footwear, and household large majority of items exhibited price increases in goods and personal care items. excess of 4 per cent and 6 per cent (on a saar basis) Core services inflation (with a weight of 23.0 per cent during March-April 2022. Although pressures relaxed in the headline CPI) also rose from 4.7 per cent in to some extent during May-July, these firmed up February 2022 to 5.2 per cent in August (Chart II.21b), again for a majority of items in August (Chart II.20). due to pressures from education (tuition and other Inflation in CPI excluding food, fuel, petrol, diesel, fees), transport services (bus/tram/taxi fare, airfare, gold and silver registered increases across both goods steamer/boat charges) and housing. Despite some and services during March-August 2022, reflecting rise, inflation in housing, the largest component in pass-through of pent-up input cost pressures to output services, remained muted in H1 (averaging 3.8 per prices (Chart II.21a). During this period, core goods cent between April-August). 2299Monetary Policy Report September 2022 Chart II.21: Contributions to CPI Inflation excluding Food, Fuel, Petrol, Diesel, Gold and Silver a: Goods b: Services 8 7 6 5.2 5 4 3 2 1 0 Note: Figures in parentheses indicate weights in CPI. Sources: NSO; and RBI staff estimates. Like exclusion-based core inflation indicators, measured by the CPI for industrial workers (CPI-IW) trimmed mean measures12 point towards a persisted below the CPI headline during March-July generalised upsurge in inflation with a peak in April 2022 and some moderation thereafter till July. Table II.2: Trimmed Mean Measures of Core The trimmed measures picked up again in August Inflation (y-o-y) (Table II.2). Month 5% 10% 25% Weighted trimmed trimmed trimmed Median Other Measures of Inflation Jun-21 5.7 5.2 5.0 5.2 Inflation measured by sectoral CPIs for agricultural Sep-21 5.0 4.9 4.8 4.3 Dec-21 5.8 5.4 5.2 4.7 labourers (CPI-AL) and rural labourers (CPI-RL) Jan-22 5.9 5.6 5.3 5.1 remained below CPI headline inflation during July Feb-22 6.0 5.7 5.3 5.6 2020-June 2022. Lower food inflation, combined with Mar-22 6.6 6.3 6.1 6.1 the high weightage of food in the CPI-AL and the CPI- Apr-22 7.3 7.0 6.6 6.5 May-22 6.4 6.1 5.5 5.7 RL vis-à-vis the CPI, contributed to the lower inflation Jun-22 6.2 6.0 5.7 5.7 prints during this period. In August 2022, with the rise Jul-22 6.1 6.0 5.7 5.7 in food prices, CPI-AL and CPI-RL inflation moved close Aug-22 6.6 6.4 6.2 6.5 to/marginally above CPI headline inflation. Inflation Sources: NSO; and RBI staff estimates. 12 While exclusion-based measures drop a fixed set of volatile items (for example, food and fuel) in each period, trimmed measures exclude items located in the tails of the inflation distribution - items displaying changes more than the specified threshold in prices each month are excluded and the items dropped differ from month to month. 3300 stniopegnatnecrepninoitubirtnoC 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 22-rpA 22-nuJ 22-guAChapter II Prices and Costs 2022 as food inflation was generally lower in the CPI- the deflators for gross value added (GVA) and gross IW vis-à-vis the CPI. Moreover, lower housing inflation domestic product (GDP) edged up sharply between in CPI-IW, paired with high weightage of housing vis-à- Q4:2021-22 to Q1:2022-23 (Chart II.22a). vis the headline, also added to the softness in CPI-IW During March-August 2022, all the major sub-groups of inflation prints. WPI remained substantially above their corresponding WPI inflation has been in double digits since April CPI subgroups (Chart II.22b). Petrol and diesel prices 2021 and increased to an all-time high of 16.6 per inflation in WPI exceeded CPI inflation, largely cent (as per the WPI series, 2011-12=100) in May reflecting the reductions in excise duty and state VAT 2022 before moderating during June-August. Despite rates which are captured in CPI but are excluded in strong favourable base effects, the spike in crude oil WPI. High energy prices in the international market and commodity prices following the war drove WPI are mirrored in the fuel and power group of the WPI. inflation during March-May 2022. The steep rise The spike in international commodity prices and in international commodity prices resulted in WPI industrial intermediaries resulted in a hardening non-food manufactured products inflation persisting of WPI non-food manufactured products inflation, in double digits during May 2021-May 2022. WPI which also contributed to WPI inflation ruling above inflation moderated to 12.4 per cent in August 2022 the CPI. Within food, WPI inflation was higher than on account of an easing of price pressures in basic CPI in cereals, vegetables, fruits, eggs and spices. metals, textiles, and food products, particularly Moreover, WPI does not include services, which is vegetable and animal oils and fats, in an environment witnessing lower inflation compared with goods of favourable base effects. In line with WPI inflation, inflation in the CPI. Chart II.22: Alternative Measures of Inflation a: Various Measures of Inflation (y-o-y) b: CPI-WPI Divergence: Select Commodities (Average during March-August 2022) 18 18 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 -2 -2 -4 -4 -6 -6 -8 -8 -10 -10 Sources: NSO; Labour Bureau; Ministry of Commerce and Industry; and RBI staff estimates. 3311 tnec reP 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 22-rpA 22-nuJ 22-guA stniopegatnecreP Vegetables 14.4 33.0 Oils and fats 11.8 9.8 Footwear 11.6 2.7 Spices 11.3 18.3 Fueland light 10.1 41.3 Clothing 9.2 4.2 Petrol 8.8 59.1 Cerealsandproducts 6.4 9.0 Milk and products 55 .3.7 Sugar andconfectionery 4.7 5.3 Diesel 4.7 71.0 Fruits 4.4 17.4 Pan,tobaccoandintoxicants 2 3.0 .6 Pulsesandproducts 0.0 0.9 CPI-WPIgap (right scale) WPI Egg -2.7 3.3 CPI-IW CPI-AL -20 0 20 40 60 80 CPI-RL CPI Per cent GVAdeflator GDPdeflator CPI WPIMonetary Policy Report September 2022 II.3 Costs Chart II.23: Farm and Non-farm Input Cost During H1:2022-23 (up to August), cost pressures Inflation (y-o-y) measured by WPI inflation in industrial raw materials and farm inputs remained firm, notwithstanding some softening. Inflation in the prices of industrial inputs – such as high-speed diesel (HSD), naphtha, aviation turbine fuel (ATF), bitumen, petroleum coke, and furnace oil – which had peaked at 34.1 per cent in May 2022 under the impact of high crude oil prices moderated to 22.1 per cent in August with the correction in crude prices (Chart II.23). After hardening during March-May 2022, the prices of * : Comprise primary non-food articles, minerals, coal, aviation turbine fuel, high non-food primary articles eased from June 2022 speed diesel, naphtha, bitumen, furnace oil, lube oil, petroleum coke, electricity, due to the moderation in the prices of fibres and cotton yarn and paper and pulp from WPI. $ : Comprise high speed diesel, fodder, electricity, fertilisers, pesticides, and oilseeds mirroring international price trends. Prices agricultural and forestry machinery from WPI. Sources: Ministry of Commerce and Industry; and RBI staff estimates. of minerals, despite mixed trends and high volatility, broadly eased during March-August 2022. During July- electricity – a key input in both industrial and farm August 2022, the pressures on industrial raw materials inputs – increased sharply due to positive momentum prices ebbed in line with the easing global metal as well as adverse base effects. prices. The export duty hike on iron ore and certain steel products also helped to contain price pressures Nominal rural wage growth for both agricultural and (Chart II.23). The farm input price inflation was largely non-agricultural labourers remained muted during driven by increase in HSD prices, agricultural and H1:2022-23 (up to July) (Chart II.24). This can be forestry machinery, fodder on account of dry weather expected to contain the build-up of a wage-price spiral conditions, and fertilisers. Inflation in price of WPI (Box II.2). Chart II.24: Wage Growth (y-o-y) and Inflation in Rural Areas (y-o-y) *: comprise ploughing, sowing, harvesting, picking, horticulture workers, fishermen, fishermen costal, loggers and wood cutters, animal husbandry, packaging, general agriculture labourers and plant protection workers. **: comprise carpenter, blacksmith, mason, weavers, beedi makers, bamboo-cane basket weavers, handicraft workers, plumbers, electrician, construction workers, LMV & tractor drivers, sweeping/cleaning workers and other non-agricultural labourers. Note: Data for April-May 2020 and 2021 were not released. Sources: NSO; Labour Bureau; and RBI staff estimates. 3322Chapter II Prices and Costs Box II.2: An Examination of the Rural Prices and Wages Dynamics in India Available data on rural wages and rural consumer price Table II.2.1: Rural Wages and Rural Prices – indices show episodes of co-movement as well as marked Panel Cointegration Results divergences (notably July 2010-October 2013 when rural Price Equation: Δln(price) Wage Equation: Δln(wage) real wages registered sharp increases, outpacing CPI Long run equation: ln(price) = Long run equation: ln(wage) = inflation) (Chart II.2.1). a x ln(wage) + ECT a x ln(price) + ECT a 0.40*** a 0.57*** In order to explore wage-price dynamics, a state-level (0.04) (0.07) cointegration panel analysis of the relationship between Short run equations rural prices (using data for CPI-Rural) and rural wages ECT -0.14*** ECT -0.12** (for agricultural and non-agricultural workers) for the (0.02) (0.05) pre-COVID period of April 2017 to February 2020 is Δln(wage) -0.05 Δln(price) -0.03 (0.06) (0.08) undertaken. Pedroni’s panel tests suggest the existence Δln(price) (-1) 0.16*** Δln(wage) (-1) -0.00 of a long-term cointegrating relation between wages and (0.05) (0.06) prices. The long and short-run dynamics are examined Δln(wage) (-1) -0.11* Δln(price) (-1) -0.22 (0.06) (0.15) on the basis of the Pooled Mean Group (PMG) estimator Rainfall deviation 0.00*** Rainfall deviation -0.00 (Pesaran et al., 1999). The long-run coefficients are below (0.00) (0.00) Constant 0.37** Constant 0.39** unity in both the prices and wage equations (0.41 and (0.05) (0.15) 0.57, respectively), indicating less than proportional Note: ***, ** and * indicate significance at 1, 5 and 10 per cent levels, increase in prices in response to wage shocks and vice respectively. Figures in parentheses indicate standard errors. versa. Turning to short-run dynamics, the coefficients 1. The sample consists of 17 major states for the period April 2017 to Feb 2020. of the error correction term (ECT) in both the equations 2. Rural wages have been calculated as a simple average of the rural agricultural and rural non-agricultural wages, following Kundu (2019). Source: RBI staff estimates. Chart II.2.1: Rural Wage Growth and Rural Inflation are significant: in the case of any shock, both prices and 25 wages adjust quickly towards their long-run levels, and 20 the speed of adjustment in prices is somewhat faster than 15 in wages (Table II.2.1). 10 References: 5 Pesaran, M. Hashem, Yongcheol Shin, and Ron Smith 0 (1999), “Pooled Mean Group Estimation of Dynamic -5 Heterogeneous Panels”, Journal of the American Statistical -10 Association, 94.446, pp. 621-634. Kundu, Sujata (2019), “Rural Wage Dynamics in India: What Role does Inflation Play”, RBI Occasional Paper, 40, Sources: NSO; Labour Bureau; and RBI staff estimates. pp. 51-84. In the organised sector, growth in staff cost broadly unchanged in the manufacturing sector (y-o-y basis) decelerated in Q1:2022-23 in both in Q1 compared to the previous quarter, while it manufacturing and services sectors. The share decreased marginally in the services sector of staff cost in the value of production was (Chart II.25). 3333 tnec reP 10-guA 20-tcO 30-ceD 50-beF 60-rpA 70-nuJ 80-guA 90-tcO 01-ceD 21-beF 31-rpA 41-nuJ 51-guA 61-tcO 71-ceD 91-beF 02-rpA 12-nuJ 22-guA Ruralwagegrowth CPI rurallabourersinflation CPI ruralinflationMonetary Policy Report September 2022 Chart II.25: Labour Cost in Manufacturing and Services a: Staff Cost in Manufacturing Sector b: Staff Cost in Services Sector Note: The staff cost growth (y-o-y) is based on common set of companies. Sources: Capitaline database; and RBI staff estimates. As per the firms polled in the Reserve Bank’s sectors may see higher pressures. Input costs and enterprise surveys13, the pace of salary outgoes for selling prices for the manufacturing, services and the manufacturing sector is expected to moderate infrastructure sector firms are likely to soften in Q3 in Q3:2022-23 while the services and infrastructure (Chart II.26). Chart II.26. Expectations of Cost Conditions (Net Response) a: Salary Outgo b: Cost of Inputs c: Selling Prices 90 80 70 60 50 46.0 40.9 40 32.5 30 20 10 0 -10 -20 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. 13 Industrial Outlook Survey; and Services and Infrastructure Outlook Survey. 3344 noisnapxE noitcartnoC )tnec repni(esnopseR teN 91-8102:3Q 02-9102:1Q 02-9102:3Q 12-0202:1Q 12-0202:3Q 22-1202:1Q 22-1202:3Q 32-2202:1Q 32-2202:3Q 90 80 70 60 50 45.1 40 27.0 30 20 19.6 10 0 -10 -20 91-8102:3Q 02-9102:1Q 02-9102:3Q 12-0202:1Q 12-0202:3Q 22-1202:1Q 22-1202:3Q 32-2202:1Q 32-2202:3Q 90 80 70 64.2 60 50 48.7 40 44.5 30 20 10 0 -10 -20 91-8102:3Q 02-9102:1Q 02-9102:3Q 12-0202:1Q 12-0202:3Q 22-1202:1Q 22-1202:3Q 32-2202:1Q 32-2202:3QChapter II Prices and Costs One-year ahead business inflation expectations Chart II.27: Input-Output Price Gap after peaking in April 2022, fell during May-July but 10 ticked up in August 2022, according to the survey by 8 the Indian Institute of Management, Ahmedabad.14 6 Survey respondents also reported that cost pressures 4 2 re-emerged in August and optimism on sales and 0 profit margins fell. -2 According to manufacturing firms polled in the -4 purchasing managers’ index (PMI) surveys, while -6 -8 input prices rose, there was an easing of the -10 momentum during May-August 2022 due to softening -12 metal and intermediate goods prices. In PMI services, input prices remained elevated, with an easing of the momentum in June-August 2022. Output price inflation for both manufacturing and services sectors Sources: S&P Global; and RBI staff estimates. was benign relative to input price inflation and the input-output price gap has moderated due to the domestic weather shocks. Consumer price inflation softening input prices momentum, coupled with peaked in April 2022. It has since then moderated, but gradual pass-through of cost burdens (Chart II.27). persists above the pre-war levels and also above the upper tolerance band. Its return to the target is expected II.4 Conclusion to be gradual. The outlook is, however, fraught with Inflationary pressures have escalated globally due considerable uncertainties, given the highly volatile to the successive black swan events – the COVID-19 geopolitical situation, spillovers from the elevated pandemic and the conflict in Ukraine. Mirroring global global financial market volatility and recurring adverse developments, India also experienced a sharp pick-up climatic conditions. Monetary policy remains focused in inflationary pressures in H1, following the jump on ensuring that inflation remains within the target in global commodity prices as well as due to adverse going forward, while supporting growth. 14 The monthly Business Inflation Expectations Survey (BIES) of the Indian Institute of Management, Ahmedabad, polls a panel of businesses, primarily the manufacturing sector, about their inflation expectations in the short and medium term. The latest survey (August 2022 round) was based on the responses of around 900 companies. 3355 paGxednI 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 22-rpA 22-nuJ 22-guA Manufacturing ServicesIII. Demand and Output Domestic economic activity exhibited resilience in H1:2022-23. The buoyancy in aggregate demand was supported by private consumption and investment demand. Geopolitical tensions, tightening of global financial markets and global economic slowdown, however, pose downside risks to the domestic outlook. Domestic economic activity exhibited resilience III.1 Aggregate Demand in H1:2022-23 in spite of some moderation in Real gross domestic product (GDP) posted a growth momentum relative to H2:2021-22. With the recovery of 13.5 per cent (year-on-year, y-o-y) in Q1:2022-23, of manufacturing and contact-intensive services, aided by favourable base effects. Accordingly, real aggregate supply conditions are improving. Aggregate GDP surpassed pre-pandemic level by 3.8 per cent demand is underpinned by private consumption, (Chart III.1 and Table III.1). All constituents of which is holding up well and set to be boosted aggregate demand recorded expansion in Q1 and were in the festival season. Investment activity gained above their respective pre-pandemic levels. traction with robust government capex. On the other The momentum – the quarter-on-quarter (q-o-q) hand, subdued government consumption and the seasonally adjusted annualised growth rate (saar) - contraction in net exports have operated as drags. was, however, negative in Q1:2022-23, pulled down by Headwinds from intensified geopolitical tensions, government consumption and a sharp jump in imports elevated international commodity prices, heightened (Chart III.1a and b). Available data for Q2 indicate that volatility in global financial markets, and slowdown aggregate demand remained buoyant, supported by in external demand are the key downside risks to the the ongoing recovery in private consumption and outlook. investment demand. Chart III.1: GDP Growth and its Constituents a: Weighted Contribution of the Components to b: GDP Growth and Momentum GDP Growth Note: saar – Seasonally adjusted annualised rate. Sources: National Statistical Office (NSO) and RBI staff estimates. 36Chapter III Demand and Output Table III.1: Real GDP Growth (y-o-y, per cent) Item 2020-21 2021-22 Weighted 2020-21 2021-22 2022-23 (FRE) (PE) Contribution* 2020-21 2021-22 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Private final consumption expenditure -6.0 7.9 -3.4 4.5 -23.7 -8.3 0.6 6.5 14.4 10.5 7.4 1.8 25.9 (1.4) (-12.7) (1.3) (8.0) (8.3) (9.9) Government final consumption expenditure 3.6 2.6 0.4 0.3 13.6 -22.9 -0.3 29.0 -4.8 8.9 3.0 4.8 1.3 (6.3) (8.2) (-16.1) (2.6) (35.1) (9.6) Gross fixed capital formation -10.4 15.8 -3.3 4.8 -45.3 -4.5 -0.6 10.1 62.5 14.6 2.1 5.1 20.1 (3.8) (-11.2) (9.5) (1.5) (15.7) (6.7) Exports -9.2 24.3 -1.8 4.6 -25.5 -6.4 -8.6 3.7 40.8 20.7 23.1 16.9 14.7 (12.8) (4.8) (12.9) (12.5) (21.2) (20.2) Imports -13.8 35.5 -3.2 7.5 -41.1 -17.9 -5.2 11.7 61.1 41.0 33.6 18.0 37.2 (16.8) (-5.1) (15.7) (26.7) (31.8) (30.3) GDP at market prices -6.6 8.7 -6.6 8.7 -23.8 -6.6 0.7 2.5 20.1 8.4 5.4 4.1 13.5 (1.5) (-8.5) (1.2) (6.2) (6.7) (3.8) 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, PE: Provisional estimates. Source: National Statistical Office (NSO). GDP Projections versus Actual Outcomes imports at 37.2 per cent in Q1 surprised significantly on the upside. The April 2022 Monetary Policy Report (MPR) had projected real GDP growth at 16.2 per cent for III.1.1 Private Final Consumption Expenditure Q1:2022-23. Actual growth undershot the projection Private final consumption expenditure (PFCE) – by 270 basis points (bps) (Chart III.2), due to a larger- the mainstay of aggregate demand – recorded a than-expected drag from net exports and sluggish solid growth of 25.9 per cent in Q1:2022-23 and growth in government expenditure. The growth in its share in overall GDP inched up to 59.9 per cent from 54.0 per cent a year ago. Expanded vaccination coverage and milder new COVID-19 infections Chart III.2: GDP Growth: Projection versus (Chart III.3) provided a fillip to consumer confidence Actual - Q1:2022-23 and discretionary spending, particularly on travel, hotels and restaurants, recreation and culture. Amongst the high frequency indicators (HFIs) of urban consumption, domestic air passenger traffic recorded a sustained recuperation, albeit still lagging its pre-pandemic levels (Chart III.4a). Passenger vehicle sales posted strong growth in Q1 and Q2, surging past pre-pandemic levels, despite headwinds from protracted supply chain disruptions (Chart III.4b). The production of consumer durables gained traction, boosted by discretionary spending (Chart III.4c). Improving urban consumption was also reflected in the acceleration in bank credit to households Sources: NSO and RBI staff estimates. (Chart III.4d). 37Monetary Policy Report September 2022 Chart III.3: COVID Infections and Vaccination a: New Cases b: Cumulative Vaccination Status (7-day moving average) (month-end) Source: Ministry of Health and Family Welfare (MoH&FW). Rural demand remained muted in Q1:2022-23, with the Mahatma Gandhi National Rural Employment some signs of recovery in Q2. Work demanded under Guarantee Act (MGNREGA) declined sharply in July- Chart III.4: Urban Demand: High-Frequency Indicators a: Domestic Air Passenger Traffic b: Passenger Vehicle Sales c: Consumer Durables d: Household Credit Sources: Directorate General of Civil Aviation (DGCA), Society of Indian Automobile Manufacturers (SIAM); NSO; and RBI. 38Chapter III Demand and Output 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; Society of Indian Automobile Manufacturers (SIAM); NSO; and Ministry of Chemicals and Fertilisers. August 2022, with improving conditions in the rural conditions in the organised sector during July 2022 farm labour market. Motorcycle sales expanded y-o-y (Chart III.6b). According to Naukri Jobspeak data, and exceeded pre-pandemic levels in August. The increased hiring was witnessed in hospitality, retail, production of consumer non-durables remained insurance, real estate, banking and financial services subdued in H1. Tractor sales remained above their segments. pre-pandemic levels, although they were lower y-o-y in III.1.2 Gross Fixed Capital Formation July-August partly due to the high base of record sales registered last year. Fertiliser sales recovered in August Gross fixed capital formation (GFCF) recorded a with the progress of kharif sowing (Chart III.5). growth of 20.1 per cent in Q1:2022-23; consequently, As per the Centre for Monitoring Indian Economy’s the share of GFCF in GDP rose to 34.7 per cent in Q1 (CMIE) Consumer Pyramids data, the labour force from 32.8 per cent a year ago. Construction activity participation rate recovered in Q2 from the dip seen exhibited buoyancy, with the housing sector recording in June, which pulled up the unemployment rate in an uptick in terms of both units launched and sold August across urban and rural segments (Chart III.6a). during Q1. The proximate coincident indicators The Employees’ Provident Fund Organisation (EPFO) of construction activity – steel consumption and payrolls data pointed to improving employment cement production – posted strong growth in H1 39Monetary Policy Report September 2022 Chart III.6: Employment Situation in India a: Unemployment and Labor Participation Rates b: Net Payroll Additions based on EPFO Records Sources: CMIE; and Employees’ Provident Fund Organisation (EPFO). (Chart III.7). Imports of capital goods were led by capital goods crossed its pre-pandemic level in June- electronics goods while the domestic production of July 2022. Chart III.7: Indicators of Investment Demand a: Imports of Capital Goods b: IIP Capital Goods c: Finished Steel Consumption d: Cement Production Sources: DGCI&S; NSO; Joint Plant Committee; and Office of Economic Adviser. 40Chapter III Demand and Output According to the RBI’s survey1, capacity utilisation (CU) Chart III.8: Capacity Utilisation in in the manufacturing sector declined to 72.4 per cent in Manufacturing Q1:2022-23 from 75.3 per cent in the previous quarter, reflecting seasonal pattern. Seasonally adjusted capacity utilisation, however, rose to 74.3 per cent in Q1:2022-23 – the highest in the last three years – from 73.0 per cent in the previous quarter (Chart III.8). Manufacturing firms recorded a sequential uptick in new orders during Q1:2022-23. Infrastructure firms displayed optimism on the overall business situation. turnover and employment in Q2:2022-23. The interest coverage ratio (ICR)2 of listed non- financial private companies in the manufacturing and information technology (IT) sectors remained high in Q1:2022-23, and indicates comfortable debt servicing Source: RBI. capacity and conducive conditions for expansion in capacity (Chart III.9). Q1:2022-23 [(-) 4.8 per cent a year ago], which dampened III.1.3 Government Consumption GDP growth (Table III.1). Revenue expenditure of the The growth in government final consumption central government rose by 4.8 per cent (y-o-y) during expenditure (GFCE) remained muted at 1.3 per cent in April-July 2022 as against a contraction of 7.0 per cent Chart III.9: Interest Coverage Ratio in Manufacturing and Services Firms Note: Data for Q1:2022-23 are based on results of 1,709 listed private manufacturing companies and 722 listed private non-financial services companies. Source: RBI staff estimates. 1 Survey of order books, inventories and capacity utilisation. 2 Interest coverage ratio is the ratio of earnings before interest and taxes (EBIT) to interest expenses and measures a company’s capacity to make interest payments on its debt. The minimum value for a viable ICR is 1. 41Monetary Policy Report September 2022 Table III.2: Central Government’s Tax Collections Item ` thousand crore Per cent Budget Estimates Actuals Per cent to BE Growth Rate 2021-22 2022-23 Apr-July Apr-July Apr-July Apr-July Apr-July Apr-July 2021 2022 2021 2022 2021 2022 A. Direct taxes 1,108.00 1,420.00 314.5 446.4 28.4 31.4 110.9 41.9 Of which 1. Corporation tax 547 720 145.9 196.5 26.7 27.3 171.5 34.7 2. Income tax 548.5 680 161.2 241.8 29.4 35.6 76.7 50.0 B. Indirect taxes 1,109.10 1,337.80 381.4 423.0 34.4 31.6 65.2 10.9 Of which 1. GST 633.3 783.7 221.0 284.2 34.9 36.3 60.4 28.6 2. Custom duties 136 213 58.0 51.0 42.6 23.9 144.1 -12.0 3. Union excise duties 335 335 100.4 85.1 30 25.4 47.9 -15.2 C. Gross tax revenue 2,217.10 2,757.80 695.9 869.5 31.4 31.5 83.1 24.9 D. Assignment to States/UTs 665.6 816.6 165.1 201.1 24.8 24.6 -6.2 21.8 E. Net tax revenue 1,545.40 1,934.80 529.2 666.2 34.2 34.4 161.0 25.9 Note: GST also includes UT-GST. Sources: Union Budget Documents and CGA. a year ago. Component-wise, the impact of higher qualitative improvement in spending – the revenue outgoes on interest payments was cushioned by lower expenditure to capital outlay (RECO) ratio decreased spending on major subsidies, especially food. Capital to 4.8 in April-July 2022 from 7.3 in the corresponding outlay, on the other hand, surged by 59.4 per cent period of the previous year (Chart III.10a). Frontloaded during April-July 2022, reflecting the government’s capital expenditure was driven by increased spending sustained thrust on infrastructure. This led to a in road and railway sectors (Chart III.10b). Chart III.10: Centre’s Expenditure during April-July a: Quality of Expenditure b: Expenditure Growth Sources: Controller General of Accounts (CGA) and RBI staff estimates. 42Chapter III Demand and Output Chart III.11: GST Collections (Centre plus States) Chart III.12: Non-tax Revenue: April-July Source: PIB. Source: CGA. On the receipts side, the central government’s gross During April-July 2022, the gross fiscal deficit (GFD) tax revenues remained buoyant, registering a growth and the revenue deficit (RD) of the central government of 24.9 per cent during April-July 2022, driven by direct at 20.5 per cent and 16.4 per cent of the full-year tax and GST collections. Monthly GST collections budget estimate (BE), respectively, were lower than in (Centre plus states) remained above `1.4 lakh crore the previous year. since March 2022, benefitting from improving As regards state governments, their consolidated GFD economic activity and compliance (Chart III.11). is budgeted at 3.3 per cent of their conslolidated GSDP Union excise duties and customs duties, however, in 2022-233 – within the 4 per cent4 limit allowed by contracted on the back of cuts in excise duty on petrol the Centre – supported by a healthy growth in revenue and diesel in May 2022 and a reduction in customs receipts (Table III.3 and Chart III.13a). The states duty on commodities such as cotton and palm oil. Table III.3: State Government Finances – The central government’s non-tax revenues fell Key Deficit Indicators during April-July due to lower dividends and profits (Per cent of GSDP) (Chart III.12). The recently concluded 5G spectrum Item 2020-21 2021-22 2021-22 2022-23 auctions would provide a total revenue of `1.5 lakh (A) (BE) (PA) (BE) Revenue Deficit 1.8 0.8 0.4 0.4 crore; of this, the first annual instalment would Gross Fiscal Deficit 3.8 3.6 2.7 3.3 amount to `17,875 crore. Disinvestment receipts Primary Deficit 2.0 1.7 1.1 1.5 jumped to `24,560 crore from `8,371 crore, driven by A: Accounts; BE: Budget Estimates; PA: Provisional Accounts. the proceeds of the initial public offer (IPO) of the Life Note: Data pertain to 29 states and UTs. Sources: Budget Documents of State Governments; Comptroller and Insurance Corporation (LIC). Auditor General (CAG) of India. 3 The data for 2022-23 pertain to 29 states/UTs. The estimates for 2021-22 (PA) have been worked out by collating the accounts (A) data for 27 states from Comptroller and Auditor General (CAG) of India, and the Budget Estimates for 2021-22 for 2 states/UT from their respective Budget Documents of 2021-22. 4 Of this 0.5 per cent will be tied to power sector reforms. 43Monetary Policy Report September 2022 Chart III.13: Trend in Key Indicators of the States/UTs a: Receipts and Expenditure of the States/UTs b: Deficit Indicators of States: April-June Notes: 1. Data in panel a pertain to 29 states/UTs. 2. Data in panel b pertain to 26 states. Sources: Budget Documents of State Governments and CAG. have continued their focus on capital expenditure, amounting `1.16 lakh crore to the states to boost with a budgeted growth of 36 per cent in capital their capex. outlay. This would increase the capital outlay-GSDP In the Union Budget 2022-23, gross and net market ratio to 2.7 per cent in 2022-23 from 2.2 per cent in borrowings were placed at `14.95 lakh crore and 2021-22 (PA). According to available data, the states’ `11.19 lakh crore, respectively. Taking into account GFD declined substantially in Q1:2022-23 on account the switch operations conducted just before the of higher revenues and devolution from the Centre Union Budget 2022-23, the gross market borrowings (Chart III.13b). Revenue expenditure of states grew by through dated securities for 2022-23 are estimated 14.3 per cent while capital expenditure contracted by at `14.31 lakh crore. The centre’s gross issuances 9.6 per cent. of market borrowings during H1:2022-23 (up to The Union Budget 2022-23 provided for a 50-year September 27, 2022) were `7.96 lakh crore (55.6 per interest-free loan of `1 lakh crore to states under cent of the full year’s budgeted amount) as against the ‘Special Assistance to States for Capital `8.45 lakh crore planned in the calendar for H1 Investment’ scheme, over and above the borrowing (Table III.4). The weighted average cost and maturity limit of 4 per cent of GSDP. In August 2022, the of issuances during H1 (up to September 27, 2022) Centre released two instalments of tax devolution were 7.3 per cent and 15.7 years, respectively, as Table III.4: Government Market Borrowings (` crore) 2020-21 2021-22 2022-23 (up to September 27) Centre States Total Centre States Total Centre States Total Net borrowings 11,43,114 6,51,777 17,94,891 8,63,103 4,92,483 13,55,586 5,68,639 1,79,878 7,48,517 Gross borrowings 13,70,324 7,98,816 21,69,140 11,27,382 7,01,626 18,29,008 7,96,000 2,76,347 10,72,347 Sources: Government of India; and RBI staff estimates. 44Chapter III Demand and Output against 6.2 per cent and 16.7 years, respectively, Chart III.14: Merchandise Trade during 2021-22. States raised gross market borrowings of `2.76 lakh crore during H1 (up to September 27, 2022), 68.8 per cent of the indicative calendar. The Ways and Means Advances (WMA) limit for the Central Government for H1:2022-23 was enhanced to `1.5 lakh crore from `1.2 lakh crore in H1:2021-22 for bridging temporary mismatches between receipts and expenditure. For states/union territories, the WMA limits were fixed at `47,010 crore effective from April 1, 2022 as recommended by the Advisory Committee on Ways and Means Advances to State Governments (Chairman: Shri Sudhir Shrivastava). III.1.4 External Demand Amidst persisting geopolitical tensions and slowing Source: DGCI&S. external demand, merchandise exports lost pace above that of exports, net exports dragged down during Q2 (July-August) after remaining resilient aggregate demand in Q1:2022-23 [(-) 8.1 per cent of during Q1. Merchandise imports, however, remained GDP as compared with (-) 5.0 per cent in Q4:2021-22 buoyant during both Q1 and Q2 (July-August), and (-) 3.0 per cent a year ago]. reflecting strong domestic demand conditions. These developments led to a widening of the merchandise In April-August 2022, merchandise exports were trade deficit (Chart III.14). Services trade, both driven by petroleum products, electronics, chemicals, exports and imports registered an impressive engineering goods and ready-made garments. performance in Q1. With the growth of imports well Exports of iron ore, cotton yarn, plastic and Chart III.15: Exports Growth a: Exports Growth-Relative Contribution b: Major Drivers of Exports in April-August 2022: Relative Contribution *Q2: July-August Sources: DGCI&S and CPB, Netherlands. 45Monetary Policy Report September 2022 Chart III.16: Imports Growth a: Imports Growth-Relative Contribution b: Major Drivers of Imports in April-August 2022: Relative Contribution *Q2: July-August Source: DGCI&S. linoleum, handicrafts and carpets were, however, and machinery. Coal imports grew substantially, restrained (Chart III.15). Export restrictions on a few despite elevated international prices, as the domestic commodities such as wheat, steel and sugar due to demand for energy soared. The trade deficit more domestic demand-supply balance also weighed on than doubled to US$ 124.5 billion in April-August merchandise exports. 2022 from US$ 53.8 billion a year ago. Merchandise exports are sensitive to global trade volumes while Rising domestic demand and high international merchandise imports are driven by domestic demand commodity prices propelled merchandise imports in (Box III.1). H1:2022-23 (April-August). Oil imports accounted for around half of this growth. Non-oil non-gold imports Services sector trade posted a robust growth in also remained strong led by coal, electronics, chemicals, H1:2022-23 (April-July), building upon the significant Box III.1: Drivers of India’s Merchandise Exports and Imports India’s share in global merchandise exports has risen goods and 41 imported goods, belonging to four major steadily from 0.9 per cent in 2005 to 1.7 per cent in groups, viz. agriculture commodities, metals, minerals 2019 (pre-pandemic). After the COVID-19 disruption, and metal products, petroleum products and chemical both exports and imports rebounded strongly in 2021- and pharmaceutical products is undertaken. 22. It is important to understand the drivers of Indian The volumes of exports and imports are determined exports and imports and assess the relevant exchange by the item-level relative prices of exports/imports5, rate and income elasticities on a disaggregated basis. For this, a panel cointegration analysis of 62 exported (Contd.) 5 The relative prices of India’s exports are derived by dividing the implied prices of India’s exported goods at item-level (dollar value by volume) by corresponding international prices, while relative prices of imports are the ratio of landed prices of item-level imports (value of imported goods divided by volume) to wholesale price indices of the relevant commodity groups. 46Chapter III Demand and Output real effective exchange rate (REER), global demand (for Table III.1.1: Determinants of Indian Merchandise exports), and domestic demand (for imports) (Raissi Exports and Imports: Pooled Mean Group Results et al 2015). Relative prices measure industry-specific Dependent Variable Log (Exports Volume) Log (Imports Volume) competitiveness while the REER (40-currency trade- or 1 2 3 4 5 6 export-weighted) is as an indicator of overall external Log (REER) -0.39* -0.37* 0.41** 0.63*** competitiveness; the empirical analysis explores the (0.22) (0.21) (0.16) (0.16) Log (Relative -0.43*** -0.38*** -0.17*** -0.16*** sensitivity of the results to both these indicators. World Price, item-level) (0.04) (0.04) (0.04) (0.04) trade volume6 and domestic demand (GDP excluding Log 1.03*** 1.30*** 1.48*** (World Trade Volume) (0.15) (0.11) (0.15) imports at constant prices) are used as indicators of Log 1.00*** 0.96*** 0.86*** global demand and domestic activity, respectively. (Domestic Demand) (0.05) (0.04) (0.05) The empirical analysis is based on pre-pandemic data ECT -0.46*** -0.41*** -0.40*** -0.58*** -0.51*** -0.51*** t-1 (0.03) (0.03) (0.03) (0.05) (0.05) (0.05) (Q1:2011-12 to Q3:2019-20), using the pooled mean Notes: ***, ** and * indicate statistical significance at 1 per cent, 5 per cent and group (PMG) estimator (Pesaran et al., 1999). 10 per cent level of significance, respectively. Figures in parentheses are robust standard errors. ECT: error correction term. The results indicate the presence of a long-run co- Source: RBI staff estimates. integrating relationship between exports, relative prices, Product (ODOP) scheme and the recently signed and the REER and global demand on the one hand, and between proposed bilateral trade agreements. imports, relative prices, REER and domestic demand, on the other hand. Productivity gains can support References exports which are also highly elastic to global demand. Raissi, M. and Volodymyr Tulin, 2015, “Price and Income Merchandise imports exhibit a strong co-movement with Elasticity of Indian Exports – The Role of Supply-Side domestic economic activity, with an elasticity close to Bottlenecks,” IMF Working Paper WP/15/161 unity. The estimated elasticity of exports with respect to REER ranges from (-) 0.37 to (-) 0.39 in alternate Pesaran, M. Hashem, Yongcheol Shin, and Ron Smith specifications and from (+) 0.41 to (+) 0.63 for imports. (1999), “Pooled Mean Group Estimation of Dynamic India’s exports could get some boost from productivity Heterogeneous Panels”, Journal of the American gains, policy initiatives like the One District, One Statistical Association, 94.446, pp. 621-634. recovery during 2021-22 (Chart III.17). Services adoption and technology are expected to keep the exports growth remained in double digits for the sector resilient. Services imports increased during fifth consecutive quarter in Q1, buoyed by software Q1 on the back of a significant upsurge in outgoes services, business, travel and transportation services. under travel, transportation and business services. Software and business services together constitute In July, services exports and imports remained more than 60 per cent share of India’s total services buoyant, albeit the growth moderated. exports. Although the risks of a recession in the US The current account deficit was 2.8 per cent of GDP in and Europe weigh on the software services sector, India’s offshoring capabilities and competencies Q1: 2022-23. The merchandise trade deficit was at 8.1 and significant investments made by the major IT per cent of GDP while the net invisibles surplus was companies towards automation, cost efficiency, cloud 5.3 per cent of GDP. 6 Released by CPB Netherlands Bureau for Economic Policy Analysis. 47Monetary Policy Report September 2022 Chart III.17: Services Trade Chart III.18: Net Foreign Direct and Portfolio Investment *: Net FDI pertains to July 2022; Net FPI is upto September 28, 2022. Source: RBI. Sources: National Securities Depository Limited (NSDL) and RBI. Turning to the financial account, net FDI flows stayed during April-August 2022, after net inflows of US$ robust at US$ 18.8 billion during April-July 2022 7.4 billion during 2021. Net flows under non- (Chart III.18). Manufacturing, retail and wholesale resident deposits moderated to US$ 1.4 billion trade, computer services, financial services, and during April-July 2022 from US$ 3.1 billion a year communication services accounted for a major share ago, due to outflows from FCNR(B) deposits and of FDI in India during Q1. Singapore, Mauritius, the lower inflows in NRE deposits. As on September UAE, the US and the Netherlands were the major 23, 2022, India’s foreign exchange reserves stood source countries of inward FDI to India, accounting at US$ 537.5 billion. for around 78 per cent of the total inflows. III.2 Aggregate Supply Foreign portfolio investors (FPIs) reduced their exposure in domestic capital market in Q1, reflecting Aggregate supply – measured by gross value added the generalised risk aversion towards EME assets (GVA) at basic prices – expanded by 12.7 per cent in in the face of the strengthening of US dollar, Q1:2022-23 (18.1 per cent a year ago), surpassing its intensified geopolitical tensions, elevated global pre-pandemic level of Q1:2019-20 by 4.7 per cent inflation and faster policy tightening by major central (Table III.5). While agriculture and services sectors banks. FPIs, however, turned net buyers in Q2 remained robust, industrial GVA growth moderated with an investment of US$ 7.5 billion (up to due to the escalation of input cost pressures and September 28). the lingering disruptions in global supply chains. External commercial borrowings (ECBs) to The momentum of GVA, measured by q-o-q saar, India recorded net outflows of US$ 2.6 billion was negative in Q1:2022-23 (Chart III.19). 48Chapter III Demand and Output Table III.5: Sector-wise Growth in GVA (y-o-y, per cent) Item 2020-21 2021-22 Weighted 2020-21 2021-22 2022-23 (FRE) (PE) Contribution 2020-21 2021-22 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Agriculture, forestry and fishing 3.3 3.0 0.5 0.5 3.0 3.2 4.1 2.8 2.2 3.2 2.5 4.1 4.5 (6.4) (5.2) (6.4) (6.7) (7.1) (9.9) Industry -1.8 9.8 -0.4 2.2 -28.1 3.0 6.2 11.6 40.4 6.6 1.5 1.0 6.0 (7.9) (0.9) (9.9) (7.8) (12.7) (7.0) Mining and quarrying -8.6 11.5 -0.2 0.3 -17.8 -7.9 -5.3 -3.9 18.0 14.5 9.2 6.7 6.5 (1.9) (-3.0) (5.5) (3.4) (2.6) (3.3) Manufacturing -0.6 9.9 -0.1 1.8 -31.5 5.2 8.4 15.2 49.0 5.6 0.3 -0.2 4.8 (9.3) (2.1) (11.0) (8.7) (15.0) (7.0) Electricity, gas, water supply and other utilities -3.6 7.5 -0.1 0.2 -14.8 -3.2 1.5 3.2 13.8 8.5 3.7 4.5 14.7 (3.6) (-3.0) (5.0) (5.2) (7.9) (11.2) Services -7.8 8.8 -4.9 5.4 -24.3 -10.4 0.0 4.3 15.5 10.0 6.6 5.0 17.5 (0.4) (-12.6) (-1.4) (6.6) (9.4) (2.8) Construction -7.3 11.5 -0.6 0.9 -49.4 -6.6 6.6 18.3 71.3 8.1 -2.8 2.0 16.8 (3.4) (-13.3) (0.9) (3.6) (20.6) (1.2) Trade, hotels, transport, communication -20.2 11.1 -4.1 1.9 -49.9 -18.8 -10.1 -3.4 34.3 9.6 6.3 5.3 25.7 (-11.3) (-32.7) (-11.0) (-4.4) (1.7) (-15.5) Financial, real estate and professional services etc. 2.2 4.2 0.5 1.0 -1.1 -5.2 10.3 8.8 2.3 6.1 4.2 4.3 9.2 (6.6) (1.1) (0.6) (14.9) (13.4) (10.5) Public administration, defence and -5.5 12.6 -0.7 1.6 -11.4 -10.2 -2.9 1.7 6.2 19.4 16.7 7.7 26.3 other services (6.4) (-5.9) (7.3) (13.3) (9.5) (18.9) GVA at basic prices -4.8 8.1 -4.8 8.1 -21.4 -5.9 2.1 5.7 18.1 8.3 4.7 3.9 12.7 (2.9) (-7.2) (1.9) (6.9) (9.8) (4.7) Note: FRE: First revised estimates; PE: Provisional estimates. Figures in parentheses are growth rates over 2019-20. Source: NSO. year ago) on the back of record rabi and horticulture Chart III.19: GVA Growth and Momentum production and resilience in allied activities. After a sluggish start, the south-west monsoon (SWM) gained momentum in July-August and the season’s rainfall stood at 7 per cent above the long period average (LPA) as on September 29, 2022 (1 per cent below LPA a year ago), with 30 out of the 36 sub-divisions receiving normal or above normal rainfall (Chart III.20a and b). Some of the key rice-producing states, however, received rainfall well below normal – Uttar Pradesh (-28 per cent), Bihar (-31 per cent), Jharkhand (-21 per cent) and West Bengal (-17 per cent). After lagging in June-July, the area under kharif sowing made a smart recovery in August. As of September 23, 2022, the total kharif sowing area was 1.7 per cent above the Sources: NSO; and RBI staff estimates. normal area (5-year average); it was, however, 1.2 per cent below a year ago due to shortfalls under rice (-5.5 III.2.1 Agriculture per cent), pulses (-3.9 per cent) and oilseeds (-0.8 per GVA in agriculture, forestry and fishing posted a cent) (Chart III.20c). The production weighted rainfall growth of 4.5 per cent in Q1:2022-23 (2.2 per cent a (PRN) index at 100 as on September 23, 2022 was a 49Monetary Policy Report September 2022 tad below its last year’s position (101 per cent) and cent of the full capacity – above the last year’s 78 per the PRN for cotton, oilseeds, pulses and coarse cereals cent as well as above the decadal average of 75 per exceeded the 5-year average (Chart III.20e and f). As of cent – brightening the prospects for the upcoming September 22, 2022, reservoir levels stood at 88 per rabi season. Chart III.20 Progress of Rainfall and Kharif sowing a: Cumulative Weekly Progress of South-west Monsoon Rainfall b: Comparative Rainfall Position c: Kharif Sowing Progress d: Reservoir Level (September 22, 2022) e: Production-weighted Rainfall Index (PRN) f: PRN Crop-wise (June 1 - September 23) (June 1 - September 23) *Normal area as on date is the average of 5 years - 2017-18 to 2021. Sources: India Meteorological Department (IMD), Central Water Commission, Ministry of Agriculture and Farmers' Welfare, Government of India, and RBI staff estimates. 50Chapter III Demand and Output According to the first advance estimates (FAE), Table III.6: Kharif Crops Production kharif 2022 foodgrains production is estimated at (Lakh tonnes) 1,499.2 lakh tonnes, 3.9 per cent below last year's Item 2019-20 2020-21 2021-22 2022-23 2022-23 fourth advance estimates (0.4 per cent below FAE of 1st AE Growth (per last year) driven by a decline of 6.1 per cent in rice cent) over 2021-22 production (Table III.6). Amongst other crops, cotton 1st AE 4th and sugarcane output are estimated to be 9.6 per cent AE and 7.7 per cent above the previous year’s level, while 1. Foodgrains 1,433.8 1,495.6 1,560.4 1,499.2 -0.4 -3.9 oilseeds output will be 1.3 per cent lower. Rice 1,019.8 1,044.1 1,117.6 1,049.9 -1.9 -6.1 Coarse cereals 336.9 364.6 359.1 365.6 7.5 1.8 The government announced an increase of 4.4 – 8.9 Pulses 77.2 86.9 83.7 83.7 -11.4 0 Tur 38.3 42.8 43.4 38.9 -12.2 -10.4 per cent in minimum support prices (MSP) for kharif Urad 13.0 16.0 19.4 18.4 -10.2 -5.2 2022-23 crops, ensuring a return of at least 50 per Moong 17.9 20.1 14.8 17.5 -14.6 18.2 2. Oilseeds (total) 223.2 240.3 238.9 235.7 0.8 -1.3 cent over the cost of production (as measured by A2 Groundnut 83.7 85.6 83.8 83.7 1.4 -0.1 plus FL7). The procurement of rice during the kharif Soyabean 112.2 129.0 130.0 128.9 1.4 -0.8 3. Cotton# 354.9 353.8 312.0 341.9 -5.6 9.6 marketing season 2021-22 (up to September 26, 2022) 4. Jute & Mesta## 99.1 95.6 103.2 100.9 5 -2.2 5. Sugarcane 3,557.0 3,992.5 4,318.1 4,650.5 10.9 7.7 at 592.8 lakh tonnes was 0.1 per cent higher over the previous year, contributing to comfortable stocks of #: Lakh bales of 170 kgs each. # #: Lakh bales of 180 kgs each. rice at 2.6 times the buffer norm (352.9 lakh tonnes), Source: Ministry of Agriculture and Farmers’ Welfare. despite the extension of cereals distribution under the Pradhan Mantri Garib Kalyan Anna Yojana (PM-GKAY). In the case of wheat, lower domestic production stocks at 248.2 lakh tonnes were marginally below the resulted in lower procurement. As on August 31, 2022, buffer norm (Chart III.21a and b). Chart III.21: Stock, Procurement and Buffer Norms Position – Rice and Wheat a: Rice b: Wheat Source: Food Corporation of India, Government of India (GoI). 7 A2 (out of pocket expenses) plus FL (family labour) includes all paid out costs such as expenses on hired labour, machines, rent paid for leased land, seeds, fertilisers, irrigation charges, depreciation as well as imputed value of family labour. 51Monetary Policy Report September 2022 III.2.2 Industry Chart III.22: Weighted Contribution to Industrial Industrial GVA recorded a y-o-y growth of 6.0 per cent GVA Growth in Q1:2022-23 (40.4 per cent in the same period a year ago, driven by base effects). All components expanded y-o-y and surpassed their Q1:2019-20 levels, despite headwinds from higher input costs and global supply chain bottlenecks (Chart III.22). Electricity, gas, water supply and other utility services registered robust growth, supported by revival of industrial activity and normalisation of services. The index of industrial production (IIP) rose by 10.0 per cent, y-o-y, during April-July (4.2 per cent above the pre-pandemic level), supported by all its constituents – mining, manufacturing and electricity (Chart III.23). Sources: NSO and RBI staff estimates. The expansion in manufacturing activity was driven Chart III.23: 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. 52Chapter III Demand and Output Chart III.24: Electricity Generation and Consumption a: Electricity Generation and Demand Growth b: Electricty Consumption: Region-wise Source: Central Electricity Authority and Power System Operation Corporation Limited (POSOCO). by beverages, wearing apparel, furniture, printing and The manufacturing purchasing managers’ index reproduction of recorded media and other transport (PMI) improved from 54.4 in Q1 to 56.3 in Q2 equipment. In terms of the use-based classification, (56.4 in July and 56.2 in August) due to a pick-up in all categories expanded y-o-y during April-July. The sales, capacity enhancements, and product production of capital goods posted double-digit growth, diversification (Chart III.26a). indicative of revival in investment activity. Consumer Overall, manufacturing, primary goods, infrastructure durables output also rose strongly, benefitting from & construction and capital goods sectors have the recovery in private consumption, especially urban demand. Chart III.25: Manufacturing Sector Profitability Electricity generation rose by 17.6 per cent (y-o-y) in Q1:2022-23 (15.3 per cent above the pre-pandemic level). Thermal and renewable sources expanded by 17.7 per cent and 28.3 per cent, respectively. In Q2 (July-August), overall electricity generation growth moderated to 2.7 per cent, partly due to abundant rainfall (Chart III.24a). Region-wise, electricity demand remained broad-based during H1 (Chart III.24b). The nominal GVA of listed manufacturing companies sustained a healthy expansion on the back of higher profits and staff costs (Chart III.25). According to the Reserve Bank’s industrial outlook survey, the Note: Data for Q1:2022-23 are based on results of 1,707 listed private manufacturing sector’s optimism waned marginally manufacturing companies. Source: RBI staff estimates based on data published by listed companies. in Q2:2022-23. 53Monetary Policy Report September 2022 Chart III.26: PMI Manufacturing and Services a: PMI Manufacturing b: PMI Services Note: >50: Expansion, < 50: Contraction. Source: S&P Global. normalised to pre-pandemic levels while consumer electricity generation, passenger vehicles and goods are trailing (Table III.7). Amongst major two-wheelers indicate buoyancy and are above their sub-sectors, steel consumption, cement production, 2019-20 output levels. Table III.7: Industrial Sector: Progress towards Normalisation (Ratio to the respective month/quarter of 2019-2020) Indicators 2020-21 2021-22 2022-23 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 July Aug 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 54.3 54.4 56.4 56.2 II Index of Industrial Production 64 94 102 106 93 103 104 108 105 102 IIP: Manufacturing 60 94 102 107 91 102 103 108 103 101 IIP: Capital goods 35 87 99 109 74 102 97 111 96 107 IIP: Infrastructure & construction goods 53 98 105 110 98 110 109 117 108 107 IIP: Consumer durables goods 32 90 107 118 72 99 103 111 92 93 IIP: Consumer non-durables goods 83 100 103 105 98 101 103 102 99 98 IIIEight Core Industries Index 76 95 100 103 96 104 105 109 109 106 ECI: Steel 51 100 103 113 97 108 105 118 103 108 ECI: Cement 62 89 96 110 97 110 104 119 114 107 Electricity demand 84 99 106 108 98 108 110 113 116 110 117 IV Production of Automobiles Passenger vehicles 16 94 120 123 83 95 100 120 106 121 125 Two wheelers 22 95 118 129 60 89 91 102 83 87 100 Three wheelers 23 45 66 84 61 60 67 83 64 71 77 Tractors 60 123 162 153 133 143 118 99 152 145 141 Sources: CMIE; CEIC; NSO; SIAM; and RBI staff estimates.  Below pre-Covid level Normalisation / recovery of activity  54Chapter III Demand and Output III.2.3 Services exceeded pre-pandemic levels in May-June 2022 but dipped marginally below in July-August. Services sector GVA rose by 17.5 per cent y-o-y in Transportation activity remained robust in H1 – Q1:2022-23 (2.8 per cent above the pre-pandemic commercial vehicle sales more than doubled y-o-y in level), supported by sustained recovery in contact- Q1, while railway freight traffic posted a growth of intensive activities, and improving consumer 11.8 per cent in Q1 and 8.1 per cent in Q2 (up to confidence and business sentiment (Chart III.27a). Trade, hotels, transport, communication, and other August). Port cargo traffic rose by 9.2 per cent in Q1 services were resuscitated by increased resumption and 11.6 per cent in Q2 (up to August) on the back of of operations and pent-up demand, but still remained buoyant international trade (Table III.9). Passenger below the pre-pandemic level by 15.5 per cent. air traffic expanded by 206.2 per cent in Q1 and 74.1 per cent in Q2 (up to August) on improving tourism High frequency indicators suggest a continued as well as business-related travels (Table III.9). broadening of traction in services activity (Table III.8). GST collections and issuances of e-way Growth in financial, real estate and professional bills – indicators of wholesale and retail trade and services improved to 9.2 per cent in Q1:2022-23 underlying overall economic activity – remained above from 2.3 per cent a year ago, aided by a revival in real pre-pandemic levels for the fourteenth straight month estate and the buoyancy in financial services. Bank in August. Construction sector activity remained credit growth accelerated to 16.2 per cent (y-o-y) as on healthy in H1, as reflected by cement production and September 9, extending support to financial services. steel consumption, benefitting from government’s In the real estate sector, new launches reached a continued focus on boosting infrastructure and 25-quarter high in Q1 and sales were at the highest improving real estate activity (Chart III.27b). in 10 quarters but still trailed pre-pandemic levels Travel and hospitality services recovered in Q1, (Chart III.28a). Housing prices grew by 3.5 per cent with increased discretionary spending and pent- (y-o-y) in Q1:2022-23, according to the RBI’s all-India up demand. The hotel industry occupancy levels housing price index, led by Chennai and Mumbai Chart III.27: Services Sector a: Service Sector Components b: Construction Indicators Sources: Office of Economic Adviser, Joint Plant Committee, Department of Industrial Policy & Promotion, Ministry of Commerce & Industry. 55Monetary Policy Report September 2022 Table III.8: Services Sector: Progress towards Normalisation (Ratio to the respective month/quarter of 2019-2020) Indicators 2020-21 2021-22 2022-23 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Jul Aug PMI: Services (>50 indicates growth over previous month) 17.2 41.9 53.4 54.2 47.2 52.4 57.3 52.3 58.7 55.5 57.2 I Construction Steel consumption 49 93 114 123 99 93 107 122 109 106 101 Cement production 62 89 96 110 97 110 104 119 114 107 II Trade, hotels, transport, communication and services related to broadcasting Commercial vehicle sales 15 80 99 143 51 99 100 170 108 Domestic air passenger traffic 7 25 50 72 31 53 81 77 95 83 87 Domestic air cargo 26 68 90 105 78 86 92 101 103 98 91 International air cargo 43 77 87 101 94 96 100 103 92 91 90 Freight traffic 79 105 111 113 110 118 119 121 123 122 131 Port cargo 80 91 103 107 102 97 104 106 111 107 109 Toll collection: volume 184 349 295 174 548 699 513 259 1035 973 979 Petroleum consumption 74 88 101 100 85 93 98 105 100 98 104 GST E-way bill 50 100 115 128 98 127 128 140 143 145 153 GST revenue 59 92 108 114 106 118 130 133 144 146 146 III Financial, real estate and professional services Credit outstanding y-o-y growth (per cent) 6.2 5.2 6.6 5.6 5.8 6.7 9.3 9.6 13.2 14.5 15.5 Bank deposits y-o-y growth (per cent) 11.0 10.5 11.5 11.4 10.3 9.4 10.3 8.9 8.3 9.1 9.5 Life insurance first year premium 81 116 97 135 87 122 107 169 122 182 139 Non-life insurance premium 95 105 104 115 107 118 113 127 133 163 153 Note: Bank credit growth since December 3, 2021 is adjusted for past reporting errors by select scheduled commercial banks (SCBs). Sources: CMIE; CEIC; NSO; MOSPI; IRDAI; RBI staff estimates.  Below pre-Covid level Normalisation / recovery of activity  (Chart III.28). Public administration, defence and in Q1:2022-23 (6.2 per cent a year ago), aided by other other services (PADO) increased by 26.3 per cent y-o-y services (education, health, recreation and cultural, Chart III.28: Housing Sector – Launches, Sales and Prices a: Housing Activity b: Housing Price Index of RBI Sources: PropTiger and RBI. 56Chapter III Demand and Output etc) even as government consumption recorded optimism propelled discretionary spending, demand muted growth. for contact-intensive activities, and investment activity. Looking ahead, good progress under kharif The PMI services remained in expansion zone in sowing, adequate reservoir levels, Government’s H1. After easing from 58.7 in Q1 to 55.5 in July, it continued thrust on capex, improved capacity rebounded to 57.2 in August (Chart III.27b). The utilisation in manufacturing, pick-up in non-food Composite PMI index was 58.0 in Q1 and 57.4 in Q2 credit and waning COVID-19 infections should support (July-August). aggregate demand and activity in H2. Geopolitical III.3 Conclusion tensions, tightening of global financial markets and Domestic economic activity was resilient in global economic slowdown, however, pose downside H1:2022-23. Consumer confidence and business risks to the domestic outlook. 57IV. Financial Markets and Liquidity Conditions During H1:2022-23, domestic financial markets adjusted smoothly to the shift in monetary policy stance and exhibited resilience to global financial market headwinds and policy spillovers from AEs. Market rates have moved higher and bank credit offtake has improved. Going forward, the RBI will remain vigilant, agile and nimble in its liquidity management operations and would use all instruments at its disposal to mitigate the spillovers of global financial market volatility on domestic financial markets. Introduction liquidity adjustment facility (LAF) corridor on April 8, 2022 at 40 basis points above the fixed rate reverse During H1:2022-23, global financial markets repo (FRRR) provided initial momentum. On average, experienced surges of volatility in the cross currents of the weighted average call rate (WACR) traded 2 basis geopolitical hostilities and aggressive monetary policy points (bps) below the SDF rate in H1:2022-23 (April actions and stances across jurisdictions to combat elevated inflation pressures. As financial conditions 8 - September 27), as compared with 2 bps below the tightened, bond yields hardened and stock markets FRRR in H2:2021-22 (Chart IV.1). Transient liquidity plunged in H1 as mounting recession fears unnerved tightness due to higher tax outflows and the resultant investor sentiments. In the currency markets, the build-up of government cash balances temporarily US dollar strengthened against major global peers firmed up the WACR above the policy repo rate in the to a 20-year high by early-September, buoyed by the fourth week of July and the second half of September. Fed’s front-loaded rate hikes, quantitative tightening, Liquidity injection through variable rate repo (VRR) and rising safe haven demand. These developments auctions mitigated the temporary liquidity stress. triggered portfolio outflows from emerging market In the overnight call money segment, the weighted economies (EMEs) and imposed sharp depreciation average rate (WAR) of traded deals was 18 bps above pressures on their currencies, exacerbating risks to macroeconomic and financial stability. Chart IV.1: Liquidity, Policy Corridor and WACR IV.1 Domestic Financial Markets Domestic financial markets were impacted by global spillovers recurringly, especially in the equities and forex segments. Money markets remained relatively insulated although interest rates hardened in response to the withdrawal of monetary accommodation domestically. Bond yields eased from mid-June highs but hardened intermittently. IV.1.1 Money Market Money market rates firmed up during H1:2022-23, reflecting policy repo rate increases by the RBI and the reduction in surplus liquidity. The institution of the Source: Reserve Bank of India (RBI). standing deposit facility (SDF) rate as the floor of the 58Chapter IV Financial Markets and Liquidity Conditions 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); RBI. the SDF rate while that of reported deals1 was 30 bps share of mutual funds (MFs) – the major lenders in the below during H1:2022-23 (April 8 - September 26), collateralised segment – in market repo declined to 46 reflecting market segmentation as small cooperative per cent from 56 per cent, partly because of reduced banks – principal lenders in reported deals – brought inflows under debt mutual funds (up to August). MFs’ in funds at lower rates towards the close of market share in TREPS at 72 per cent in H1 was, however, hours (Chart IV.2a). The average monthly volume of traded deals at `1.39 lakh crore was higher Chart IV.3: Share in Overnight Money Market Volumes than `1.01 lakh crore in the reported segment (Chart IV.2b). The share of reported deals in the total call money market volume declined to about 34 per cent in September 2022 from 68 per cent in March 2022, due to increased participation by public sector and foreign banks. Money market activity remained dominated by the collateralised segments with the share of the uncollateralised call money market remaining at 2.0 per cent in H1:2022-23 (up to September 27). The share of triparty repo (TREPS) moderated to 73 per cent from 76 per cent a year ago, with a corresponding increase in the share of market repo to 25 per cent Sources: CCIL; RBI. from 22 per cent (Chart IV.3). Among investors, the 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. 59Monetary Policy Report September 2022 unchanged. On the borrowing side, the share of public Chart IV.4: Money Market Rates and sector banks (PSBs) increased to 66 per cent from 64 Policy Corridor per cent in TREPS and to 19 per cent from 16 per cent in market repo over the same period. Interest rates on longer-term money market instruments – 3-month T-bills (TBs), certificates of deposit (CDs) and commercial paper (CPs) – moved higher during H1:2022-23. The spreads of TBs, CDs and CPs were 51 bps, 72 bps and 87 bps, respectively, above the SDF rate in H1:2022-23 (April 8 - September 26) as against 26 bps, 38 bps and 88 bps, respectively, above the FRRR during H2:2021-22 (Chart IV.4). The issuances of CDs increased to `2.96 lakh crore in H1:2022-23 (up to September 23) from `1.73 lakh crore in H2:2021-22, reflecting banks’ demand for Sources: FBIL and RBI. funds to meet the buoyant credit offtake. Mobilisation of resources through the issuances of CPs, however, issuances firmed up to 5.50 per cent in H1:2022- fell to `7.20 lakh crore during H1:2022-23 (up to 23 from 4.47 per cent in H2:2021-22. Corporates September 26) from `10.09 lakh crore in H2:2021-22 remained the major issuers of CPs, with their share (Chart IV.5a), as the appetite for bank credit improved. increasing to 60.2 per cent in H1:2022-23 from 53.3 The weighted average discount rate (WADR) of CP per cent in H2:2021-22 (Chart IV.5b). Chart IV.5: Primary Issuances of Commercial Paper a: Systemic Liquidity, Issuances and WADR b: Institutional Break-up Sources: RBI; CCIL;F-TRAC; and RBI staff estimates. 60Chapter IV Financial Markets and Liquidity Conditions by 64 bps during Q1, driven by (i) the rise in US yields Table IV.1: Maturity Profile of CP Issuances and crude prices; (ii) the announcement of a larger (` lakh crore) than anticipated Central Government borrowing Tenor H1: 2021-22 H2: 2021-22 H1: 2022-23 (up to September 26) auction calendar for H1:2022-23; (iii) higher than 7- 30 days 4.13 4.14 0.69 expected March and April CPI inflation prints; and 31-90 days 3.12 3.30 3.93 (iv) the repo rate hike of 40 bps in an unscheduled 91-180 days 2.05 1.82 1.84 181-365 days 0.80 0.83 0.74 meeting in May along with the 50 bps hike in the cash Total 10.11 10.09 7.20 reserve ratio (CRR) (Box IV.1). Outstanding 3.71 3.52 4.33 (as at end-period) In Q2 (up to September 27), the benchmark yield Sources: CCIL;F-Trac and RBI. softened by 20 bps owing to the fall in crude prices, lower CPI inflation for July vis-à-vis June, the return Most of the CP issuances were in the 31-90 days of foreign portfolio investors (FPIs) as net buyers in maturity segment (Table IV.1). The WADR of issuances August-September and expectations of India’s likely in this maturity segment firmed up to 5.45 per cent in inclusion in global bond indices. Reflecting these H1:2022-23 (up to September 26) from 3.97 per cent factors, the 10-year yield moderated from its peak in H2:2021-22. of 7.66 per cent (on June 16, 2022) to 7.09 per cent IV.1.2 Government Securities (G-sec) Market on September 13; it, however, rose to 7.30 per cent During H1:2022-23, G-sec yields exhibited two-way on September 27, 2022 reflecting policy rate hikes by movements (Chart IV.6). The generic 10-yr yield rose major central banks and higher global bond yields. Chart IV.6: 10-year Generic G-sec Yield, Repo Rate and Liquidity Conditions Higher than US FOMC raised rates by 75 bps expected H1 borrowing Higher CPI Sources: RBI and FBIL. 61Monetary Policy Report September 2022 Box IV.1: Monetary Policy Surprises and Financial Markets Efficient financial markets are believed to price in the change/monetary policy surprise; is the anticipated anticipated component of policy actions. In order to assess policy change; D toD are dummies to capture major 1 4 the true impact of policy announcements on the market policy developments3; refers to the change in interest rates, it is essential to segregate the surprise Brent crude prices; and refers to element (which the market might not have been able to the corresponding changes in US rates one day prior to predict) from the anticipated component of monetary the policy announcement. policy (Kuttner, 2001). High frequency financial market The empirical analysis indicates that anticipated policy variables such as overnight indexed swaps (OIS), futures changes are not significant for 10-year government and stock prices can be used to identify policy surprises securities and 5-year corporate bonds – only the surprise (Gertler and Karadi, 2015). element has an impact on the yields of these securities Akin to the global evidence, the OIS is found to reliably (Table IV.1.1). The cumulative effect at the end of 2 days capture market expectations of the future path of the is higher (and significant) than the same day impact, policy rate in India. Monetary policy surprises are suggesting that the markets take time to absorb policy identified by using the change in the 2-month OIS rate (given the bi-monthly policy cycle) on the policy day, Table IV.1.1: Policy Impact on Financial Markets while the residual is assumed to be the anticipated policy change. By narrowing the window around the policy Variables 91-days T-bill 10-year G-sec AAA 5-year Corp. bonds announcement day, the change in the OIS rate can be 1 day 2 days 1 day 2 days 1 day 2 days reasonably attributed to monetary policy surprises. The effect effect effect effect effect effect change in the 2-month OIS rate on policy days may also (1) (2) (3) (4) (5) (6) contain a surprise on the path of expected future policy Surprise 0.721*** 1.094*** 0.284*** 0.792*** 0.875*** 1.060*** rates provided by the central bank’s forward guidance. (0.153) (0.121) (0.072) (0.224) (0.196) (0.221) Anticipated 0.216*** 0.211*** 0.025 0.005 0.011 0.001 This policy surprise is identified by splitting the change (0.053) (0.039) (0.033) (0.067) (0.033) (0.071) in policy rate/monetary policy decision into two parts D 0.119*** 0.240*** 0.101*** 0.030 0.076*** 0.095*** 1 (0.012) (0.013) (0.008) (0.022) (0.012) (0.022) – anticipated and unanticipated policy change (eq. 1) D -0.599*** -0.434*** 0.049 -0.057 -0.141*** -0.069** (Ahokpossi et al., 2020) – as follows: 2 (0.047) (0.061) (0.029) (0.067) (0.020) (0.032) D 0.139*** 0.145*** 0.052*** 0.169*** 0.248*** 0.260*** 3 (0.013) (0.037) (0.016) (0.030) (0.018) (0.017) … (1), D -0.172*** -0.262*** 0.024 0.023 0.056 0.018 4 (0.054) (0.038) (0.035) (0.084) (0.053) (0.087) where, i is the policy rate, t is the time index and is Change in -0.010 -0.024*** 0.000 0.000 0.001 0.010 the market expectation at time t-1 of the policy rate at time Brent prices (0.009) (0.008) (0.008) (0.012) (0.009) (0.011) t. is the change in the policy rate which is bifurcated Change in 0.063 -0.405 - - - - US 91-days (0.336) (0.330) into an unanticipated component ( ) and an anticipated T-bill, lag 1 portion ( ). The hypothesis that only the unanticipated Change in US - - - - 0.161 -0.070 5-years G-sec, (0.304) (0.272) decisions/surprises may have a significant impact on lag 1 market rates is put to test for the key markets (91-days Change in - - 0.258 -0.127 - - US 10-years (0.160) (0.373) Treasury Bills, 10-years G-sec and AAA rated 5-years G-sec, lag 1 corporate bonds) in an event study (ES) framework2, using Constant -0.036*** -0.027** -0.011* -0.006 -0.017 -0.018 (0.011) (0.010) (0.006) (0.015) (0.010) (0.013) the following specification: Observations 37 37 37 37 37 37 Adjusted R2 0.861 0.896 0.310 0.518 0.698 0.626 LM test 0.69 0.81 0.03 0.10 0.16 0.03 (p-value) … (2) Note: Figures in parentheses refer to the Newey-West standard errors where, is the change in market interest rates (corrected for heteroscedasticity and autocorrelation). ***,**,* denote levels of significance at 1%, 5% and 10%, respectively. (dependent variable); is the unanticipated policy Source: RBI staff estimates. (Contd.) 2 The sample period covers the flexible inflation targeting (FIT) regime (October 2016 – August 2022). 3 D refers to the dummy for the April 6, 2017 policy meeting when the RBI narrowed the width of the LAF corridor from 100 bps to 50 bps; D refers to 1 2 the dummy for the March 27, 2020 meeting when policy measures were announced through an off-cycle meeting after the outbreak of the pandemic; D 3 refers to the dummy for the April 8, 2022 meeting when the RBI instituted the SDF; and D refers to the dummy for an off-cycle meeting on May 4, 2022 4 when the RBI announced increase in the policy repo rate by 40 bps and CRR by 50 bps. 62Chapter IV Financial Markets and Liquidity Conditions surprises. In the case of treasury bills, while both surprise Market”, Journal of Monetary Economics, Vol. 47, Issue as well as anticipated policy changes matter, the surprise 10, pp. 523-544. component is the major driver. Overall, interest rates in Gertler, M., and Karadi, P. (2015), “Monetary Policy money and bond markets in India are found to respond Surprises, Credit Costs, and Economic Activity”, American significantly mainly to policy surprises in conformity with Economic Journal: Macroeconomics, Vol. 7(1), pp. 44-76. the efficient market hypothesis. Ahokpossi, C., Isnawangsih, A., Naoaj, M. S., and Yan, T. References: (2020), “The Impact of Monetary Policy Communication Kuttner, K. N. (2001), “Monetary Policy Surprises and in an Emerging Economy: The Case of Indonesia”, IMF Interest Rates: Evidence from the Fed Funds Futures Working Paper, WP/20/109. Yields on T-bills firmed up across tenors in sync The dynamics of yield curve movements are captured with the increases in the policy repo rate and the by its level, slope, and curvature4. While the average introduction of the SDF (Chart IV.7). level of yields hardened by 64 bps, the slope flattened by 206 bps during H1:2022-23 (up to September 26) Average trading volume in both G-secs and T-bills increased year-on-year in H1:2022-23 (up to September due to relatively higher increase in the short-term 26) (Chart IV.8). The weighted average yield of traded rates consequent to policy tightening (Chart IV.9). maturities for G-sec and T-bills increased by 95 bps Alongside, the curvature declined perceptibly by 190 and 144 bps, respectively. bps indicating a reduction in the hump of the curve, Chart IV.7: FBIL -T-Bill Benchmark (Yield to Maturity) Source: FBIL. 4 The level is the average of par yields of all tenors up to 30-years published by FBIL and the slope (term spread) is the difference in par yields of 3-months and 30-year maturities. The curvature is calculated as twice the 14-year yield minus the sum of 30-year and 3-month yields. 63Monetary Policy Report September 2022 Chart IV.8: Trading Volumes and Yield a: G-Sec b: T-Bills Sources: CCIL and RBI staff estimates. as the yield hardening in the mid-segment of the To facilitate debt consolidation, the Reserve Bank curve was less than in the short and long segments. conducted six switch auctions on behalf of the Central Government amounting to `56,103 crore during In the Indian context, unlike the AEs, the level and H1:2022-23 (up to September 27, 2022). The weighted curvature of the yield curve have more information average maturity (WAM) of the outstanding stock content on future macroeconomic outcomes than the of G-sec increased to 11.94 years as on September slope.5 Chart IV.9: G-Sec Yield Curve a: Shifts b: Changes in Level and Slope Sources: FBIL and RBI staff estimates. 5 Patra, M.D., Joice, J., Kushwaha, K.M., and I. Bhattacharyya (2022). What is the Yield Curve telling us about the Economy? Reserve Bank of India Bulletin, June. 64Chapter IV Financial Markets and Liquidity Conditions to September 27) (Chart IV.10). The average inter-state Chart IV.10: SGS - Amount Raised and Spread spread on securities of 10-year tenor (fresh issuances) was 3 bps in H1:2022-23 (4 bps in H2:2021-22). IV.1.3 Corporate Bond Market Corporate bond yields moved higher in H1, broadly tracking G-sec yields. The average yield on AAA- rated 3-year bonds issued by non-banking financial companies (NBFCs) and corporates increased by 156 bps (to 7.52 per cent) and by 170 bps (to 7.56 per cent), respectively, in H1:2022-23 (up to September 27). The yield on issuances by public sector undertakings (PSUs), financial institutions (FIs) and banks rose by 143 bps to 7.25 per cent (Chart IV.11a). The average risk premium (measured by spread over Source: RBI. 3-year G-sec yields) increased from 35 bps to 41 bps for NBFCs, from 25 bps to 45 bps for corporates while 27, 2022 from 11.71 years at end-March 2022. The it moderated from 21 bps to 14 bps for PSUs, FIs and weighted average coupon (WAC) at 7.15 per cent banks (Chart IV.11b). during H1 (up to September 27) remained higher than The increase in risk premia was seen in other tenors 7.11 per cent as at end-March 2022. (albeit more at longer segments) and rating spectrum The weighted average spread of cut-off yields on as well (Table IV.2). The 3-year credit default swap state government securities (SGS) over G-sec yields of (CDS) spreads for the papers trading overseas of State comparable maturities was 32 bps in H1:2022-23 (up Bank of India and ICICI Bank increased by 32 bps Chart IV.11: AAA-rated 3-Year Corporate Bond Yield and Spread: Sector-wise a: Yields b: Spreads Source: Fixed Income Money Market and Derivatives Association of India (FIMMDA). 65Monetary Policy Report September 2022 mobilisation in the corporate bond market (98.4 Table IV.2: Financial Markets - Rates and Spread per cent) was through the private placement route. Instrument Interest Rates Spread (bps) (over (per cent) corresponding risk-free Outstanding investments by FPIs in corporate bonds rate) declined to `1.16 lakh crore on September 27, 2022 Mar Sep Variation Mar Sep Variation 2022 2022 (in bps) 2022 2022 (in bps) from `1.21 lakh crore at end-March, pulling down the 1 2 3 (4 = 3-2) 5 6 (7 = 6-5) utilisation of the approved limits from 19.9 per cent Corporate Bonds to 18.3 per cent. The daily average secondary market (i) AAA (1-yr) 5.03 6.84 181 28 13 -15 (ii) AAA (3-yr) 5.86 7.56 170 25 45 20 trading volume during Q1 at `6,054 crore was 20 per (iii) AAA (5-yr) 6.43 7.50 107 -1 22 23 cent below its level in the corresponding period of the (iv) AA (3-yr) 6.57 8.31 174 96 120 24 previous year (Chart IV.12b). (v) BBB-minus (3-yr) 10.24 11.97 173 463 486 23 Note: Yields and spreads are computed as monthly averages. Data up to IV.1.4 Equity Market September 27, 2022. Source: FIMMDA. Domestic equity market registered minor losses in H1: 2022-23, exhibiting greater resilience and 33 bps, respectively during H1: 2022-23 (up to than most of its global peers (Chart IV.13a). The September 27, 2022). benchmark indices bounced off their multi-month The issuances of corporate bonds in the primary market lows registered in June 2022 as the correction in increased to `1.94 lakh crore during H1 (up to August commodity prices, good progress of the monsoon, 2022) from `1.81 lakh crore during the corresponding healthy corporate earnings results and return of FPI period of 2021-22 (Chart IV.12a), compensating for the flows restored investors’ confidence. However, the lack of overseas issuances as against `55,152 crore US Fed's 75 bps policy rate hike in September 2022 raised abroad in H1:2021-22. Nearly the entire resource along with its hawkish stance led to a global sell-off Chart IV.12: Corporate Bond Market Activity a: Primary Market Issuances b: Secondary Market Turnover - Daily Average Source: SEBI. 66Chapter IV Financial Markets and Liquidity Conditions Chart IV.13: Stock Market Performance a: Global Equity Market Performance b: Share of Global Equity Markets to World Market c: India VIX Capitalisation (Per cent) Source: Bloomberg. in equity markets. Overall, the BSE Sensex declined consecutive months (October 2021-June 2022), the by 2.5 per cent in H1:2022-23 (up to September 27, longest selling streak since 2000. Foreign investors, 2022) to close at 57,108. Indian equities account for however, returned to the domestic equity market 3.5 per cent of total world market capitalisation, in July, attracted by the improvement in corporate the fifth largest in the world (Chart IV.13b). The earnings and strong macro fundamentals. Domestic India VIX – which captures the short-term expected institutional investors (DIIs) made heavy purchases in volatility of Nifty 50 – fell from its 20-month high of the equity market for 17 consecutive months (March 32.0 on February 24, 2022 to 21.6 on September 27, 2021-July 2022), absorbing FPI sell-off pressures 2022 (Chart IV.13c). and enabling the market to outperform global and EMEs as an asset class experienced selling other emerging market peers. Overall, FPIs were net pressures from FPIs in 2022 amidst heightened sellers to the tune of `58,438 crore, while DIIs were geopolitical tensions and rapid monetary policy net buyers to the tune of `1.3 lakh crore in H1:2022- normalisation by global central banks (Chart IV.14a). 23 (Chart IV.14b). Moreover, activity in the domestic In India, equity markets witnessed sell-offs for nine primary market remained subdued in H1:2022-23 67Monetary Policy Report September 2022 Chart IV.14: EME flows, Institutional Investments and IPO Issuances in India a: EME FPI Flows and Volatility b: Net Investment in Indian Equities by c: Amount Raised through IPOs/FPOs Institutional Investors Sources: Institute of International Finance, Bloomberg, Capitaline, NSDL and SEBI. (barring the mega LIC IPO) due to volatile conditions 4.8 per cent during H2:2021-22 (Chart IV.15b). Market (Chart IV.14c). interventions by the RBI contained volatility and ensured orderly movement of the INR. The Reserve IV.1.5. Foreign Exchange Market Bank announced several measures on July 6, 2022 to The Indian rupee (INR) traded with a depreciating enhance capital inflows with the objective of ensuring bias against the US dollar (USD) in H1:2022-23 overall macroeconomic and financial stability.7 (Chart IV.15a). Reflecting the global factors, the INR During 2022-23 (up to September 27), the US dollar volatility – measured by the 1-month at the money appreciated by 16.1 per cent against a basket of major (ATM) option implied volatility6 – rose to an average currencies while the INR depreciated by a lower order of 5.25 per cent during H1 (up to September 27) from of 6.8 per cent against the US dollar (Chart IV.16), 6 Implied volatility is derived from an option’s price and depicts the markets’ expectations about the future volatility of the currency. 7 These measures included temporary exemption from CRR and statutory liquidity ratio (SLR) on incremental FCNR(B) and NRE term deposits, permitting banks temporarily to raise fresh FCNR(B) and NRE deposits without reference to the extant regulations on interest rates effective July 7, 2022, increase in limit under automatic route for external commercial borrowing and relaxations pertaining to FPI investment norms in debt market and foreign currency lending by authorised dealer category I (AD Cat-I) banks. 68Chapter IV Financial Markets and Liquidity Conditions Chart IV.15: INR - US Dollar Movements a: Movements of Indian Rupee and US Dollar b: 1-month ATM Implied Volatility Sources: FBIL; Bloomberg; and Thomson Reuters. faring better than many AEs and EME peers. The INR’s inflation is lower than the weighted average of its relatively better performance is attributed to stronger major trading partners8. Despite a drawdown, India’s macroeconomic fundamentals and buffers – India’s foreign exchange reserves at US$ 537.5 billion (as on Chart IV.16: Cross-Currency Movements a: Movement of Major EME Currencies against US Dollar b: Movement in REER (September 26, 2022 over end-March 2022) (August 2022 over March 2022) Sources: RBI; FBIL; IMF; Thomson Reuters; and Bank for International Settlements (BIS). 8 In the 40-currency REER, trading partners account for 91 per cent of India’s merchandise trade, 88.4 per cent of world GDP and 86.4 per cent of world trade. In August 2022, India’s inflation was 0.8 percentage point lower than these 40 trading partners. 69Monetary Policy Report September 2022 September 23) are the fifth largest globally9 which, Table IV.3: Nominal and Real Effective Exchange in conjunction with net forward purchases, provide Rate Indices (Trade-weighted) insulation from external shocks and resilience. (Base: 2015-16 = 100) In terms of the 40-currency nominal effective Item Index: Appreciation (+) / exchange rate (NEER), the INR appreciated by 0.2 per September 23, Depreciation (-) (Per cent) 2022 (P) cent between March 2022 and September 23, 2022 September 23, 2022 over March (average) 2022 (Table IV.3). It also appreciated by 1.1 per cent in terms 40-currency REER 104.6 1.1 of the 40-currency real effective exchange rate (REER) 40-currency NEER 92.9 0.2 during this period. 6-currency REER 104.7 3.7 6-currency NEER 88.0 1.8 Forward premia declined during H1 reflecting `/US$* 81.37 -6.3 narrowing interest rate differentials on the back of *: As on September 27, 2022. a faster than expected tightening by the US Fed. The P: Provisional. Sources: RBI; and FBIL. one-month forward premium averaged 3.36 per cent during H1 (up to September 27) down from 3.93 per Although credit growth (y-o-y) picked up for both cent during H2:2021-22 (Chart IV.17). public sector banks (PSBs) and private sector banks IV.1.6 Credit Market (PVBs) in H1:2022-23, it remained higher for PVBs During H1:2022-23, bank credit10 growth accelerated (20.4 per cent vis-à-vis 13.9 per cent for PSBs) in tandem with improving economic activity. Growth (Chart IV.19a). The share of PSBs in total incremental in non-food bank credit increased to 16.7 per cent credit extended by all scheduled commercial banks (y-o-y) as on September 9, 2022 from 9.7 per cent as at (SCBs) on a y-o-y basis, however, was higher than that end-March 2022 (Chart IV.18). of PVBs (Chart IV.19b). Chart IV.17: Forward Premium Movements Chart IV.18: Non-food Credit Growth of SCBs Source: Bloomberg. Source: RBI. 9 Comparison based on data available up to September 16, 2022. 10 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). 70Chapter IV Financial Markets and Liquidity Conditions Chart IV.19: Credit Flow across Bank-Groups a: Growth b: Share in Incremental Credit Source: RBI. The improvement in bank credit was seen across all normal monsoon and the enhanced target for major sectors11 (Chart IV.20). Credit to the agriculture agricultural credit12. sector grew by 13.4 per cent (y-o-y) in August 2022 Credit growth to industry recovered to 11.4 cent (13.0 per cent a year ago), supported by the above- in August from 1.5 per cent a year ago, led by large Chart IV.20: Sectoral Deployment of Bank Credit a: Sector-wise Credit Growth b: Share in Incremental Non-food Credit (y-o-y) Source: RBI. 11 Sectoral non-food credit data are based on sector-wise and industry-wise bank credit (SIBC) return, which covers select banks accounting for about 93 per cent of total non-food credit extended by all SCBs. 12 The government raised the agriculture credit target of `16.5 lakh crore for 2021-22 to `18 lakh crore for 2022-23. 71Monetary Policy Report September 2022 industry and sustained growth in the micro, small ago. Credit growth to infrastructure was driven by the and medium enterprises (MSME) segment. Credit to power sector, reflecting strong growth in electricity large industries expanded by 6.4 per cent in August, generation (Chart IV.21c and d). after remaining in contraction zone for a substantial After witnessing a slide during the COVID-19 period, due to higher working capital requirements pandemic, services sector credit offtake gained traction and industrial activity. The extension of the Emergency in H1:2022-23, led by disbursements to NBFCs (which Credit Line Guarantee Scheme (ECGLS) helped push up registered 27.8 per cent growth in August 2022 as credit growth in respect of micro and small industries against contraction of 1.0 per cent a year ago). Credit to 28.2 per cent in August 2022 from 12.1 per cent growth in contact intensive sectors such as tourism, a year ago, with incremental credit (y-o-y) flows to hotels and restaurants remained broadly stable MSMEs exceeding that to large industry (Chart IV.21a (Chart IV.22). and b). Among the major industries, credit growth to the infrastructure sector (accounting for 38.0 per Retail loans remained the major driver of overall credit cent of outstanding industrial credit) accelerated to growth. Within retail loans, growth in housing loans 11.0 per cent in August 2022 from 3.3 per cent a year was sturdy (16.4 per cent in August 2022 as compared Chart IV.21: Bank Credit in Industry Sector – Size-wise and Type-wise a: Credit Growth - Size-wise b: Incremental Credit c: Credit Growth to Industrial Sector - d: Credit Growth-Infrastructure Sector Major Constituents Source: RBI. 72Chapter IV Financial Markets and Liquidity Conditions Chart IV.22: Credit Growth in Services Sector a: Credit Growth in Major Components of b: Growth in Bank Credit to NBFCs Services Sector Source: RBI. with 11.6 per cent a year ago) while vehicle loans per cent in June 2022 from 7.5 per cent a year ago strengthened (19.5 per cent in August 2022 vis-à-vis (Chart IV.24a). Asset quality improved across all the 11.1 per cent a year ago). Credit card loans bounced major sectors (Chart IV.24b). back in H1:2022-23 with the ebbing of new COVID-19 Banks’ non-SLR investments – covering instruments infections and the rebound in consumer demand like CPs, bonds, debentures and shares of public (Chart IV.23). and private corporates – were lower during The asset quality of SCBs improved, with the overall H1:2022-23, mainly due to a decline in investment non-performing assets (NPA) ratio declining to 5.6 in bonds/debentures (Chart IV.25a). Adjusted Chart IV.23: Personal Loans Growth Source: RBI. 73Monetary Policy Report September 2022 Chart IV.24: Stressed Assets and Non-Performing Assets of SCBs a: Overall Loan Portfolio of SCBs b: Sectoral Non-Performing Assets Source: RBI. non-food credit13 growth at 14.9 per cent as on demand and time liabilities (NDTL) as on August September 9 (y-o-y basis) was higher than 9.1 per 26, 2022 from 10.4 per cent at end-March 2022 cent as at end-March 2022 (Chart IV.25b). (Chart IV.26). Excess SLR holdings provide collateral Reflecting the improvement in credit offtake, excess buffers to banks for availing funds under the LAF holdings of statutory liquidity ratio (SLR) securities and are also a component of the liquidity coverage of SCBs moderated to 8.8 per cent of their net ratio (LCR). Chart IV.25: Non-SLR Investment and Adjusted Non-Food Credit a: Non-SLR Investment b: Adjusted Non-Food Credit *: Up to September 9, 2022. Source: RBI. 13 Adjusted non-food credit is the sum of non-food credit of banks and their non-SLR investments and captures better the overall flow of funds from the banks to the commercial sector. 74Chapter IV Financial Markets and Liquidity Conditions Table IV.4: Transmission from the Repo Rate to Banks’ Deposit and Lending Rates (Variation in basis points) Period Repo Term Deposit Rates Lending Rates Rate WADTDR WADTDR EBLR 1 - Year WALR WALR (Fresh Deposits) (Outstanding MCLR (Fresh (Outstanding Deposits) (Median) Rupee Rupee Loans) Loans) Retail Retail and Retail and Bulk Deposits Bulk Deposits Deposits February 2019 to March 2022 -250 -209 -259 -188 - -155 -232 -150 April to August/September 2022* +140 39 91 26 140 70 70 39 Of which April 2022 0 0 -9 0 0 0 -12 -2 May to August/September 2022* +140 39 100 26 140 66 82 41 Note: WALR: Weighted average lending rate; WADTDR: Weighted average domestic term deposit rate; EBLR: External benchmark-based lending rate; MCLR: Marginal cost of funds-based lending rate. Data on EBLR pertain to 31 domestic banks. *: Latest data on WALRs and WADTDRs pertain to August 2022. Source: RBI. rates recorded during the easing phase (February Chart IV.26: Excess SLR of Banks 2019-March 2022) of monetary policy (Table IV.4). The mandated external benchmark regime introduced in October 2019 for loan pricing in select sectors has strengthened the interest rate channel of monetary transmission. The proportion of outstanding floating rate loans linked to external benchmarks has increased from 9.1 per cent in March 2020 to 46.9 per cent in June 2022. Concurrently, the share of marginal cost of funds-based lending rate (MCLR) linked loans has come down to 46.5 per cent in June 2022 (Table IV.5). The bulk of external benchmark-based lending rate (EBLR) loans (80 per cent of total in June 2022) are *: Up to August 2022. linked to the policy repo rate. Accordingly, banks Source: RBI. raised their EBLRs for fresh loans by 140 bps during IV.2 Monetary Policy Transmission Table IV.5: Outstanding Floating Rate Rupee Loans of SCBs across Interest Rate Benchmarks Banks’ deposit and lending rates moved higher in (Per cent to total) H1:2022-23 in tandem with increases in the policy March March March June 2020 2021 2022 2022 repo rate beginning May 2022. The weighted average Base rate regime 10.3 6.4 4.9 4.3 lending rate (WALR) on fresh rupee loans sanctioned MCLR regime 78.3 62.3 48.6 46.5 during May-August 2022 increased by 82 bps while External benchmark regime 9.1 29.5 44.0 46.9 Others 2.3 1.8 2.5 2.3 that on outstanding rupee loans increased by 41 bps, Note: Data pertain to 74 scheduled commercial banks. reversing in part the sizeable moderation in these Source: RBI. 75Monetary Policy Report September 2022 May-September 2022. The 1-year median MCLR of Chart IV.27: Bank-wise Lending Rates and Share SCBs – which is an internal benchmark – rose by of EBLR linked Loans 70 bps in H1, in line with pressures on their cost of deposits and other funding sources. The increase in the share of EBLR-linked loans, the shorter reset periods of such loans and upward adjustment in MCLRs have increased the pace of transmission to WALR on outstanding loans (Chart IV.27). Across domestic banks, the increase in the WALRs on fresh rupee loans for PSBs exceeded that of PVBs during May-August 2022, partly reflecting the higher share of floating rate loans in the case of the former. During the easing phase also, the pass-through to lending rates of PSBs had exceeded that of PVBs (Chart IV.28 a and b). The lending rates of PSBs Source: RBI. Chart IV.28: Bank Group wise Transmission to Lending and Deposit Rates a: Easing Phase (February 2019-March 2022) b: Tightening Phase (May 2022-August 2022) c: Lending Rates of Domestic Banks Source: RBI. 76Chapter IV Financial Markets and Liquidity Conditions Chart IV.29: Sector wise Transmission to WALRs of Domestic Banks a: Fresh Rupee Loans b: Outstanding Rupee Loans Note: 'Other personal loans' include personal loans other than housing, vehicle, education and credit card loans. Source: RBI. remain lower than that of PVBs (Chart IV.28c). The Table IV.6: Loans linked to External Benchmark – transmission to lending and deposit rates was the Spread of WALR (Fresh Loans) over the Repo Rate maximum in the case of foreign banks, reflecting a (Per cent) higher share of low cost and lower duration wholesale Sectors March 2022 August 2022 deposits in their total liabilities. Public Private Domestic Public Private Domestic sector banks banks sector banks banks The WALRs on both fresh as well as outstanding rupee banks banks loans increased across all the sectors during May- MSME loans 4.32 4.12 4.23 4.14 3.53 3.76 Personal loans August 2022 (Chart IV.29). Housing 2.85 3.47 3.15 2.66 2.43 2.52 Vehicle 3.23 2.79 3.06 3.09 3.21 3.10 The spreads charged by domestic banks over the Education 4.28 5.45 4.51 4.25 4.64 4.37 policy repo rate (in the case of floating rate fresh rupee Other personal 3.17 6.06 3.36 3.75 6.39 3.97 loans loans where the repo rate is the external benchmark) moderated in case of MSME, housing and education Source: RBI. loans in H1:2022-23 (Table IV.6). 77Monetary Policy Report September 2022 Banks also raised their term deposit rates in (Chart IV.30c). The transmission to WADTDR on H1:2022-23 amidst moderation in systemic liquidity outstanding deposits is also picking up albeit (Chart IV.30a)14. Banks increased their bulk term gradually, reflecting the preponderance of term deposit15 rates more relative to retail deposit rates deposits contracted at fixed rates (Table IV.4). The (Chart IV.30b) - the weighted average domestic term weighted average savings deposit rate of SCBs was 3.0 deposit rate (WADTDR) on fresh retail deposits per cent in August 2022, unchanged from April 202216. increased by 39 bps during May-August 2022, while Interest rates on various small savings instruments the WADTDR on total fresh deposits (both retail and (SSIs) – which are fixed on a quarterly basis with a bulk deposits) increased by 100 bps. The median term spread of 0-100 bps over and above G-sec yields of deposit rate on fresh retail deposits – the prevailing card comparable maturities – have been revised upwards in rates – increased by 26 bps during May-September 2022 the range of 10-30 bps for Q3:2022-23, after remaining Chart IV.30: Surplus Liquidity, Credit Condition and Transmission to Term Deposit Rates a: Credit Growth, Deposit Rate and Liquidity Conditions b: Bank wise Transmission to Retail and Bulk c: Maturity wise Transmission to Fresh Term Deposit Deposit Rates* (May to August 2022) Rates (May to August 2022) *:Deposit rates are WADTDRs on fresh deposits. Note: Data on median term deposit rate on fresh deposits pertain to the period May-September 2022. Source: RBI. 14 The incremental credit-deposit ratio increased from 37 per cent on April 9, 2021 to 111.6 per cent on September 9, 2022. 15 Bulk deposits are single rupee term deposits of `2 crore and above for SCBs (excluding regional rural banks) and small finance banks. 16 Term deposits constituted 57.1 per cent of aggregate deposits of SCBs in June 2022, while current account and savings account deposits were 8.9 per cent and 34 per cent, respectively. 78Chapter IV Financial Markets and Liquidity Conditions Table IV.7: Interest Rates on Small Savings Instruments 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 Q3:2022-23) for Q3:2022-23 (Jun 2022 -Aug 2022) (1) (2) (3) (4) (5) = (3) + (4) (6) (7) = (6) - (5) Savings Deposit - - - - 4.00 - Public Provident Fund 15 0.25 7.47 7.72 7.10 -62 Term Deposits 1 Year 1 0 6.09 6.09 5.50 -59 2 Year 2 0 6.33 6.33 5.70 -63 3 Year 3 0 6.57 6.57 5.80 -77 5 Year 5 0.25 7.04 7.29 6.70 -59 Recurring Deposit Account 5 0 6.57 6.57 5.80 -77 Monthly Income Scheme 5 0.25 7.00 7.25 6.70 -55 Kisan Vikas Patra 123 Months# 0 7.47 7.47 7.00 -47 NSC VIII issue 5 0.25 7.23 7.48 6.80 -68 Senior Citizens Saving Scheme 5 1.00 7.04 8.04 7.60 -44 Sukanya Samriddhi Account Scheme 21 0.75 7.47 8.22 7.60 -62 $: Spreads for fixing small saving rates as per Government of India Press Release of February 2016. #: Current maturity is 123 months. Note: Compounding frequency varies across instruments. Sources: Government of India; FBIL; and RBI staff estimates. unchanged for nine consecutive quarters. With G-sec framework of monetary policy. Moreover, it is also yields moving higher, the prevailing interest rates a financial stability tool in addition to its role in on various schemes are 44-77 bps below the formula liquidity management. The MSF rate was retained implied rates for Q3: 2022-23 (Table IV.7). at 25 bps above the policy repo rate; thus, the width of the LAF corridor was restored to its pre-pandemic IV.3 Liquidity Conditions and the Operating level of 50 bps and became symmetrical around the Procedure policy repo rate again. The FRRR was retained at 3.35 The Reserve Bank of India (RBI) Act, 1934 requires per cent. Akin to the MSF, access to the SDF is at the RBI to place the operating procedure relating to the discretion of banks, unlike repo/reverse repo, the implementation of monetary policy and changes open market operation (OMO) and cash reserve ratio thereto from time to time, if any, in the public (CRR) which are at the discretion of the RBI. domain. In April 2022, significant changes in the In H1:2022-23, the focus of liquidity management operating procedure were instituted through the moved to gradual, calibrated withdrawal of surplus introduction of the SDF at 3.75 per cent – 25 bps liquidity in a non-disruptive manner. This was in below the policy repo rate (then prevailing at 4.00 sync with the shift in the focus of monetary policy per cent) and 40 bps above the FRRR – as the floor of from remaining accommodative during 2021-22 to the LAF corridor, replacing the FRRR. The SDF rate withdrawal of accommodation to contain inflationary is applicable on uncollateralised overnight deposits. pressures and anchor inflation expectations. The MPC By removing the binding collateral constraint on raised the policy repo rate by 140 bps during May- the central bank, the SDF strengthens the operating August 2022. With the institution of the SDF at 40 bps 79Monetary Policy Report September 2022 above the FRRR in April, the cumulative increase in the Chart IV.31: CiC vis-à-vis Volume of Digital effective interest rate was 180 bps. Furthermore, the Payments CRR was increased by 50 bps to 4.50 per cent (effective fortnight beginning May 21, 2022), withdrawing primary liquidity from the banking system. Drivers and Management of Liquidity Surplus liquidity moderated in H1:2022-23, driven by the public’s currency demand, net forex outflows and the build-up in government’s cash balances. The drainage of liquidity due to expansion in currency in circulation (CiC) in H1 was lower than a year ago, partly reflecting the growing use of digital payments (Chart IV.31). The build-up of government cash balances also contributed to the leakage of liquidity *: Up to July 2022. from the banking system. The drawdown by banks of Source: RBI. their excess reserves partially ameliorated liquidity pressures (Table IV.8). the average daily liquidity absorption under the LAF fell from `7.8 lakh crore in April to `2.1 lakh In terms of management of liquidity by the RBI, crore in September (up to September 27). Due to OMO sales and the increase in CRR by 50 bps sucked out liquidity from the banking system in H1. The transient liquidity pressures on account of GST consequent moderation in surplus liquidity was payments, the borrowing under the MSF window reflected in lower absorptions under the LAF – rose to `59,312 crore (outstanding amount) on July Table IV.8: Liquidity – Key Drivers and Management (` crore) 2021-22 2022-23 Q1 Q2 H1 Q1 Q2* Drivers (i) CiC [withdrawal (-) /return (+)] -1,26,266 54,921 -71,344 -83,887 50,530 (ii) Net Forex Purchases (+)/ Sales (-) 1,60,843 1,42,395 3,03,238 16,159 -1,68,975# (iii) GoI Cash Balances [build-up (-) / drawdown (+)] -2,23,740 -5,600 -2,29,340 -3,73,117 67,863# (iv) Excess Reserves [build-up (-) / drawdown (+)] 1,17,219 -9,884 1,07,335 1,50,165 -48,559# Management (i) Net OMO Purchases (+)/ Sales (-) 1,38,965 97,960 2,36,925 -6,620 -14,460 (ii) Required Reserves [including both change in NDTL -87,827 -6,586 -94,463 -1,03,054 -10,463 and CRR] Memo Item Outstanding Net LAF as at the end of period 4,71,970 7,58,132 7,58,132 2,44,891 26,152^ *: Data are up to September 23, 2022; #: Data are up to July 29, 2022; ^: Data as on September 27, 2022. Note: (+) / (-) sign suggests accretion/depletion in banking system liquidity. Data on drivers and management pertain to the last Friday of the respective periods. Source: RBI. 80Chapter IV Financial Markets and Liquidity Conditions 25, 2022, – the highest since April 1, 2019 (`94,263 to September 27) while the remaining amount was crore). Advance tax outflows and GST payments absorbed through variable rate reverse repo auctions temporarily moderated surplus liquidity in the third (both main and fine-tuning operations) (Chart IV.32). week of September. The RBI conducted variable rate In view of the moderation in surplus liquidity, banks repo (VRR) auctions of `50,000 crore each of 3 days appetite to park funds with the Reserve Bank for longer and overnight maturity on July 26 and September maturities waned. Consequently, the amount absorbed 22, 2022, respectively. The RBI remains vigilant on through the variable rate reverse repo auctions declined the liquidity front and would conduct two-way fine- to 40 per cent of the total absorption in September 2022 tuning operations as necessary – both variable rate (up to September 27) from around 74 per cent in March repo (VRR) and variable rate reverse repo (VRRR) 2022. The effective absorption rate17 at 5.25 per cent in operations of different tenors – depending on the September 2022 (up to September 27) was higher than evolving liquidity and financial conditions. the SDF rate of 5.15 per cent. Since its inception on April 8, 2022, the monthly IV.4 Conclusion average absorption under the SDF has been in the Domestic financial markets have adjusted smoothly to range of `1.2-2.7 lakh crore during H1:2022-23 (up the shift in monetary policy’s focus on withdrawal of accommodation, policy rate hikes and the moderation Chart IV.32: Surplus Liquidity - Average in surplus liquidity, while exhibiting resilience to Absorption under the LAF global financial market headwinds and policy spillovers from AEs. Market rates have moved higher across the maturity spectrum albeit at varying degrees across market segments and instruments. Bank credit offtake has improved in line with economic activity, even as lending and deposit rates have started moving higher. The foreign exchange market has been characterised by an orderly adjustment of the INR, with a depreciating bias due to the generalised strength of the US dollar. Going forward, the RBI will remain vigilant, agile and nimble in its liquidity management operations and would use all instruments at its disposal to mitigate the spillovers of global financial market volatility on *: Up to September 27, 2022. Sources: RBI and RBI staff estimates. domestic financial markets. 17 The weighted average rate of absorptions under the FRRR/SDF and VRRR of longer maturities with the absorbed amount under each facility being the weights. 81V. External Environment The global outlook has worsened under the combined impact of the protracted conflict in Ukraine, and aggressive and synchronised monetary tightening. These developments are imparting sizeable volatility to global financial markets and large adverse spillovers to emerging market economies. Supply chain disturbances, the energy and food crises and tightening financial conditions are exacerbating risks of a global recession. The global outlook has worsened since the April 2022 The Euro area’s GDP grew by 3.1 per cent (q-o-q MPR under the combined impact of the protracted saar) in Q2:2022, its fastest pace in three quarters, war, and aggressive and synchronised monetary boosted by the easing of COVID-19 restrictions and a tightening to rein in multi-decadal highs in inflation. resurgence in tourism. High frequency indicators for Sovereign bond yields have hardened while equity Q3, however, suggest slowdown in momentum due to markets have corrected in response to monetary growing uncertainty surrounding future gas supplies policy actions. Geopolitical tensions, the faster pace and the rising costs of living. The composite PMI of monetary tightening by the US Fed, and the safe for the Euro zone registered its second consecutive haven demand have led the US dollar to rally to 20- contraction in August 2022 at 48.9, with downturns year highs, imposing depreciation pressures on the in both manufacturing and services. The outlook is currencies of major emerging market economies overcast by the war and perniciously high inflation, (EMEs) in an environment of large portfolio outflows. with expectations of tighter financial conditions going Lingering supply chain disturbances, the energy and forward. food crises and tightening financial conditions are In the UK, GDP contracted by 0.3 per cent in Q2:2022 exacerbating risks of a global recession. (q-o-q saar) due to a fall in government and consumer V.1 Global Economic Conditions spending, deceleration in production output and contraction in services constrained by labour Global growth lost momentum in Q2:2022. High shortages. The labour market remains tight with frequency indicators point to a further slowdown some early signs of weakening in labour demand. The in Q3. The US economy contracted in H1:2022 composite PMI plummeted to 49.6 in August 2022, [(-) 1.6 per cent and (-) 0.6 per cent in Q1 and the first contraction in 18 months, driven by severe Q2, respectively, in terms of quarter-on-quarter downturn in manufacturing output and slowdown in (q-o-q) seasonally adjusted annualised rates (saar)], services business activity. The Bank of England (BoE) dragged down by inventories and residential fixed forecasts a decline in GDP in Q3:2022 till the end of investment (Table V.1). In contrast, the US labour 2023 under the adverse impact of the sharp rise in market remains robust, with sustained payroll gains global energy and goods prices on UK households’ real and a low unemployment rate. Nominal wage growth disposable incomes. has been strong, albeit with signs of levelling off. The US composite Purchasing Managers’ Index (PMI)1 at Japan’s GDP grew by 3.5 per cent (q-o-q saar) in 44.6 in August remained in contraction territory for Q2:2022 following a near stagnation in Q1 as the second consecutive month, with declines in both private consumption accelerated with the lifting manufacturing and services output. of COVID-19 curbs, and government spending rose 1 The references to PMIs are to S&P Global indices, unless specified otherwise. 82Chapter V External Environment for the second straight quarter. The employment Table V.1: Real GDP Growth and income situation improved moderately on the (Per cent) whole, buoyed by accommodative monetary policy. Country Q3- Q4- Q1- Q2- 2021 2022 2023 2021 2021 2022 2022 (P) (P) The composite PMI (au Jibun Bank) dropped sharply Quarter-on-quarter, seasonally adjusted annualised rate (q-o-q, saar) to 49.4 in August 2022, the first contraction since Canada 5.3 6.6 3.1 3.3 February, with both manufacturing and services Euro area 9.0 2.0 2.7 3.1 companies recording a decline in output. The Bank Japan -1.8 3.9 0.2 3.5 of Japan (BoJ) expects growth to be under pressure South Korea 0.9 5.5 2.6 3.0 UK 3.8 5.2 3.1 -0.3 stemming from elevated commodity prices though US 2.7 7.0 -1.6 -0.6 the economy is projected to continue growing at a Year-on-year pace above its potential growth rate. Advanced Economies Amongst EMEs, China's GDP growth decelerated Canada 3.8 3.2 2.9 4.6 4.5 3.4 1.8 sharply to 0.4 per cent (y-o-y) in Q2:2022 from 4.8 per Euro area 3.7 4.6 5.4 4.1 5.4 2.6 1.2 Japan 1.2 0.5 0.6 1.6 1.7 1.7 1.7 cent in Q1, marking the second-worst quarterly growth South Korea 4.1 4.4 3.0 2.9 4.1 2.3 2.1 in 30 years (Table V.1). On q-o-q (annualised) basis, UK 6.9 6.6 8.7 2.9 7.4 3.2 0.5 the economy contracted by 10 per cent in Q2:2022 as US 5.0 5.7 3.7 1.8 5.7 2.3 1.0 COVID-related lockdowns curbed economic activity Emerging Market Economies amidst a steep downturn in the real estate sector and Brazil 4.0 1.7 1.7 3.2 4.6 1.7 1.1 an energy crunch. H1:2022 growth at 2.6 per cent China 4.9 4.0 4.8 0.4 8.1 3.3 4.6 India 8.4 5.4 4.1 13.5 8.7 7.4 6.1 (y-o-y) was below the 5.5 per cent annual growth target Indonesia 3.5 5.0 5.0 5.4 3.7 5.3 5.2 for 2022. The composite PMI (Caixin) was at 53.0 in Philippines 7.0 7.8 8.2 7.4 5.7 6.7 5.0 August, driven by an expansion in services activity, Russia 4.0 5.0 3.5 -4.1 4.7 -6.0 -3.5 South Africa 3.0 1.7 2.7 0.2 4.9 2.3 1.4 offset by a marked slowdown in manufacturing growth. Thailand -0.2 1.8 2.3 2.5 1.5 2.8 4.0 Looking ahead, the zero-COVID policy, strained power Memo: supply and the liquidity crisis in the real estate sector World 2021 2022 (P) 2023 (P) are likely to weigh on economic activity. Year-on-year Amongst other major EMEs, Brazil’s GDP growth rate Output 6.1 3.2 2.9 accelerated to 3.2 per cent (y-o-y) in Q2:2022 from 1.7 Trade Volume 10.1 4.1 3.2 per cent in Q1, supported by private and government P: Projection. Note: India's data correspond to fiscal year (April-March); e.g., 2021 spending, and investment. The unemployment rate pertains to April 2021-March 2022. fell to a multi-year low in June. The composite PMI Sources: Official statistical agencies; Bloomberg; IMF WEO Update, July 2022; and RBI staff estimates. eased to 53.2 in August, with notable slowdown evident in both the manufacturing and service 2022 from a 14-month high of 52.7 in July. Looking sectors. Going forward, tight monetary conditions, ahead, COVID-19 infections risk due to low vaccination high inflation and war-related uncertainty remain key levels, weak employment outlook and continued risks to the growth outlook. South Africa’s GDP growth disruptions to power supply could weigh on economic decelerated sharply to 0.2 per cent (y-o-y) in Q2 driven activity. The Russian economy contracted by 4.1 per by the devastating floods in the KwaZulu-Natal region cent (y-o-y) in Q2:2022 due to the fallout from the and power rationing hampering industrial activity. conflict with Ukraine and the impact of international The composite PMI edged lower to 51.7 in August of sanctions. Consumer activity remains subdued, but 8833Monetary Policy Report September 2022 Table V.2: Select Macroeconomic Indicators for BRICS2 Economies Real GDP Growth Country 2021 2022(P) 2023(P) General Govt. Country 2021 2022(P) 2023(P) Rate (Y-o-Y Per cent) Gross Debt Brazil 4.6 1.7 1.1 (Per cent of GDP) Brazil# 93.0 91.9 92.8 Russia 4.7 -6.0 -3.5 Russia 17.0 16.8 18.9 India 8.7 7.4 6.1 India 86.8 86.9 86.6 China 8.1 3.3 4.6 China 73.3 77.8 81.8 South Africa 4.9 2.3 1.4 South Africa 69.1 70.2 73.4 CPI Inflation Rate Country 2021 2022(P) 2023(P) Current account Country 2021 2022(P) 2023(P) (Per cent) balance (Per cent Brazil 8.3 8.2 5.1 of GDP) Brazil -1.7 -1.5 -1.6 Russia 6.7 21.3 14.3 Russia 6.9 12.4 8.1 India 5.5 6.1 4.8 India -1.2 -2.9 -2.5 China 0.9 2.1 1.8 China 1.8 1.1 1.0 South Africa 4.5 5.7 4.6 South Africa 3.7 1.3 -1.0 General Govt. Net Country 2021 2022 (P) 2023(P) Forex Reserves* Country 2020 2021 2022 Lending/Borrowing (in US$ billion) (Per cent of GDP) Brazil -4.4 -7.6 -7.4 Brazil 355.6 362.2 339.7 Russia 0.7 -4.0 -5.3 Russia 596.1 630.6 565.7 India -10.4 -9.9 -9.1 India 588.4 635.3 545.7 China -6.0 -7.7 -7.1 China 3536.0 3606.2 3454.4 South Africa -6.4 -5.8 -6.1 South Africa 54.2 57.8 59.6 P: Projection. *: Forex reserves for 2022 pertains to August 2022 except China (July 2022), South Africa (July 2022) and India (September 16, 2022). #: Gross debt refers to the nonfinancial public sector, excluding Eletrobras and Petrobras, and includes sovereign debt held by the central bank. Note: India's data correspond to fiscal year (April-March). Sources: Official statistical agencies; WEO April 2022 database and July 2022 Update, IMF; Fiscal Monitor Update, April 2022, IMF; and International Reserve and Foreign Currency Liquidity (IRFCL), IMF. it is beginning to recover, while investment is facing Amongst high frequency indicators, the OECD the brunt of sanctions and capital outflows. Soaring composite leading indicators (CLIs) for August energy prices have helped the external sector hold up 2022 remained below trend for most economies, relatively well. The economy is expected to contract indicating a deteriorating outlook due to multi- in both 2022 and 2023 due to the war and sanctions decadal high inflation, low consumer confidence (Table V.2). and declining stock price indices (Chart V.1a). The global composite PMI fell from 50.8 in July to 49.3 Growth in the ASEAN3 economies decelerated in August, indicating a contraction in global output in Q2:2022 as the war dampened demand. The for the first time since June 2020, with fall in both manufacturing PMI for these economies in August services and manufacturing output (Chart V.1b). signalled improvement in business conditions as output and new orders expanded and employment The moderation in world trade, which started in and purchasing activity increased. The slowdown the third quarter of 2021, accentuated in H1:2022 in China is a major source of risk to the region due owing to the war and slowdown in global growth to spillovers from supply disruptions and weaker in a worsening macroeconomic environment exports. (Chart V.2a). Reflecting this, the merchandise trade 2 BRICS includes Brazil, Russia, India, China, and South Africa. 3 Association of Southeast Asian Nations (ASEAN) includes Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam. 8844Chapter V External Environment Chart V.1: Survey Indicators a: OECD CLI b: Composite PMI Sources: OECD; and Bloomberg. volume growth slowed from 4.6 per cent in Q1:2022 was, however, lower by 70.1 per cent from its peak to 4.3 per cent in Q2:2022; however, it witnessed in October 2021, but remained above its pre-COVID an uptick in July 2022. The WTO expects trade level (Chart V.2b). volume growth to moderate to 3.0 per cent in 2022 V.2 Commodity Prices and Inflation from 9.8 per cent in 2021. The Baltic Dry Index, which measures shipping costs for a wide variety Global commodity prices have witnessed large of bulk commodities such as coal and iron ore, swings since February following the war. Commodity increased in September 2022 on sequential basis. It prices initially surged by 14.7 per cent (according Chart V.2: World Trade Volume a: World Trade Volume: Relative Contribution b: World Trade Volume and Baltic Dry Index *: Data for Sep-22 are for Sep 1- 27, 2022. Sources: CPB Netherlands; and CEIC. 8855Monetary Policy Report September 2022 to the Bloomberg commodity price index) during Crude oil prices were highly volatile in H1:2022. They March-May 2022 as the war started. Since then (June- hovered above US$100 per barrel between April and September 28, 2022), the prices have corrected by July due to the war and sanctions related uncertainty 14.2 per cent as slowing global growth dampened in an environment of acutely tight supply conditions demand. Notwithstanding this correction, the (Chart V.3c). Amidst extremely low inventories, the Bloomberg commodity price index has gained 13.7 Organization of the Petroleum Exporting Countries per cent year to date (till September 28) (Chart (OPEC) plus countries continued with calibrated V.3a). Global food prices, according to the Food and changes in production quotas. OPEC plus decided Agriculture Organization (FAO), eased by 13.6 per to increase production by 100,000 barrels per day in cent between March’s all-time record high and August August 2022 but in September, it decided to curtail 2022, as seasonal production gained and reduction in production by a similar magnitude starting October. restrictive trade policies assuaged supply conditions. On the back of slowing global demand, strengthening The index, however, increased by 3.2 per cent in US dollar and expectations on the availability of 2022 (up to August) (Chart V.3b). Iranians supplies, crude oil prices declined sharply Chart V.3: Commodity Prices a: Bloomberg Commodity Price Index b: Food Price Indices c: Energy and Crude Oil Prices d: Metal Price Indices Sources: FAO; World Bank; and Bloomberg. 8866Chapter V External Environment during July-September 2022. Nevertheless, Brent Table V.3: Consumer Price Inflation crude prices have gained 15.0 per cent year to date (Per cent) (till September 28). Natural gas prices have jumped Country Inflation Q3: Q4: Q1: Q2: July August significantly since the war; in August 2022, the Target 2021 2021 2022 2022 2022 2022 prices (according to World Bank’s natural gas index) Advanced Economies increased by 91.7 per cent in 2022 and remained 249.2 Canada 2.0 4.1 4.7 5.8 7.5 7.6 7.0 per cent higher on year-on-year basis. Euro area 2.0 2.9 4.7 6.1 8.0 8.9 9.1 Japan 2.0 -0.2 0.5 0.9 2.5 2.6 3.0 Base metal prices, measured by Bloomberg’s base South Korea 2.0 2.5 3.6 3.8 5.4 6.3 5.7 metal spot index, which rose by 17.1 per cent UK 2.0 2.8 4.9 6.2 9.2 10.1 9.9 US 2.0 5.4 6.7 8.0 8.7 8.5 8.3 on the back of the war, softened by 34.8 per cent (4.3) (5.5) (6.3) (6.5) (6.3) between April and September 2022 (up to September Emerging Market Economies 28), reflecting a weak global outlook. Gold prices Brazil 3.50 ± 1.5 9.6 10.5 10.7 11.9 10.1 8.7 plummeted markedly since April, hitting a low at Russia 4.0 6.9 8.3 11.5 16.9 15.1 14.3 US$1,618 per troy ounce in September as bond yields India 4.0 ± 2.0 5.1 5.0 6.3 7.3 6.7 7.0 China 0.8 1.8 1.1 2.2 2.7 2.5 hardened and the US dollar traded stronger. For some South Africa 3.0-6.0 4.8 5.5 5.8 6.6 7.8 7.6 metals like zinc and aluminium, production cuts Mexico 3.0 ± 1.0 5.8 7.0 7.3 7.8 8.2 8.7 amidst high energy prices have lent support to prices Indonesia 3.0 ± 1.0 1.6 1.8 2.3 3.8 4.9 4.7 Philippines 3.0 ± 1.0 4.1 3.6 3.3 5.5 6.4 6.3 in August. In September, however, prices treaded the Thailand 1.0-3.0 0.7 2.4 4.7 6.5 7.6 7.9 downward trajectory following other metal prices Turkey 5.0 19.3 25.8 54.8 74.0 79.6 80.2 (Chart V.3d). Notes: (1) Inflation for US is in terms of year-on-year change in consumer price index with personal consumption expenditure price Consumer Price Inflation index year-on-year change in parentheses. (2) The Bank of Canada aims to keep inflation at the 2 per cent Consumer price inflation ratcheted up across mid-point of an inflation control target range of 1-3 per cent. economies due to sustained cost push pressures (3) Brazil’s inflation target for 2021 was 3.75 ± 1.5 per cent. Sources: Central bank websites; and Bloomberg. from elevated food and energy prices, rising wage cost and lingering pandemic-induced supply chain terms of the personal consumption expenditure (PCE) bottlenecks as strong rebound in domestic demand price index – the Federal Reserve (Fed)’s preferred in a number of economies added to price pressures. Headline inflation breached inflation targets across measure of inflation – moderated from 6.8 per cent AEs and EMEs over the course of 2022 so far (Table in June to 6.3 per cent in July, driven by decrease in V.3). High energy and food prices have been the prices of both goods and services. Core PCE inflation major drivers of the upsurge in inflation, with goods eased to 4.6 per cent in July from 5.2 per cent in March inflation generally much higher than services, though (Chart V.4a). the latter has also started to gather pace recently. In the Euro area, CPI inflation soared to a historic high Core inflation is also ruling at elevated levels in of 9.1 per cent in August 2022, prevailing well above many economies due to the interplay of cost-push the European Central Bank (ECB)’s target of 2 per cent shocks and demand-pull pressures. since July 2021. The precipitous increase in energy In the US, headline CPI inflation reached a 40-year prices, especially of natural gas, along with food high of 9.1 per cent in June 2022, driven by inflation prices, remained the major driver of inflation. Non- in energy and food prices. It eased to 8.3 per cent in energy industrial goods, transportation and fertiliser August due to a fall in gasoline prices. Inflation in costs have also fuelled price pressures. CPI inflation in 8877Monetary Policy Report September 2022 the UK rose to 10.1 per cent in July – the highest since China, CPI inflation has remained subdued, although availability of data in January 1997 – and well above it accelerated during March-July 2022, mainly due to a the BoE’s target of 2 per cent, led by housing and surge in food prices and a strong recovery in demand. household services, transport and food. It moderated In August, however, it moderated to 2.5 per cent as marginally to 9.9 per cent in August as transport both food and non-food indices eased. sub-index declined. In Japan, CPI inflation in all items V.3 Monetary Policy Stance less fresh food – the Bank of Japan’s target measure – With inflation rates at their highest in decades and rose to 2.8 per cent in August, the highest in 7 years. It has breached the 2 per cent target since April 2022. significantly above targets, central banks in AEs and CPI inflation also rose to 3.0 per cent in August 2022 EMEs resorted to aggressive monetary tightening from 2.6 per cent in July, amidst surging fuel and food with larger-than-usual rate hikes in 2022 to contain costs as well as a sharply weakening yen. inflation and anchor inflation expectations even as economic activity is losing momentum. A number of Like the AEs, inflation in major EMEs remains elevated central banks in EMEs were already in a tightening and well above their respective targets. In Brazil, CPI mode in 2021. The synchronised monetary tightening inflation was 8.7 per cent in August 2022 (Chart V.4b). has raised concerns as to whether it will lead to a In Russia, inflation peaked at 17.8 per cent in April recession or whether the central banks will be able to from 9.2 per cent in February following sanctions and achieve a soft landing (Box V.1). a sharp depreciation of the rouble. It has since then moderated gradually to 14.3 per cent in August, partly After initiating the tightening cycle in March 2022, the due to currency appreciation. In South Africa, CPI US Fed has delivered rate hikes in all its subsequent inflation stood at 7.6 per cent in August – exceeding the policy meetings. In May, the US Fed effected a 50 bps central bank’s target range since May 2022 – as prices increase in the federal funds rate. It followed up with of food and non-alcoholic beverages increased. In 75 bps hikes in its June, July and September meetings – Chart V.4: CPI Inflation – Select Economies a: Advanced Economies b: Emerging Market Economies Sources: Official statistical agencies; and Bloomberg. 8888Chapter V External Environment Box V.1: High Inflation and Aggressive Monetary Tightening: Soft or Hard Landing? With inflation rates ruling at their highest since the 1970s At the current juncture, inflation is running high while and 1980s in major economies and substantially above GDP growth is slowing even as unemployment rates targets, central banks have stepped up the pace and the remain low. This macroeconomic mix raises the odds of quantum of rate hikes to keep inflation expectations hard landing. anchored and to bring inflation back to targets. This has Table V.I.1: Macroeconomic Factors — raised growing concerns that the synchronised monetary Hard and Soft Landings tightening could land the global economy into a recession Variables Advanced Emerging Market (a hard landing). Central banks hope that they would be Economies Economies able to engineer a soft landing (with only a loss of pace in Soft Hard Soft Hard landings landings landings landings growth rather than an outright contraction in economic Conditions Inflation (%) 1.5*** 2.2*** 4.0** 4.9** activity) (BIS, 2022; Blinder, 2022). at the start of the GDP growth (%) 3.3* 2.5* 3.1* 4.4* A panel analysis of 8 countries with 23 tightening tightening Real policy rate (%) 3.5*** 0.0*** 2.3*** 4.2*** cycle5 cycles over the period Q1:1997-Q2:2022 suggests that Change in household 0.7 0.5 -0.7* 0.1* credit-to-GDP (% pts)6 for both AEs and EMEs, hard landings are preceded by Fiscal deficit-to-GDP -1.6 -3.1 -1.5 -2.2 significantly higher average inflation as compared to soft (% pts) Debt-to-GDP (% pts) 37.4 56.0 37.9 48.9 landings4 (Table V.I.1). Low GDP growth in the period Conditions Real policy rate -0.1 2.0 1.2 0.6 prior to the start of tightening increases the probability during increase (% pts) tightening of a hard landing in AEs. In EMEs, high GDP growth in Average quarterly real 0.0 0.1 0.1 0.0 rate increase (% pts) conjunction with high inflation tilts the scales towards Tightening duration 6.0 10.3 5.2 6.4 hard landing. For EMEs, elevated fiscal deficits and public (quarters) debt prior to the start of monetary tightening increase Note: ***,**,* denote level of significance at 1%, 5% and 10%, respectively, for testing equality of means between hard and soft landings using Student’s t test. the risk of them ending in recession post the tightening. Sources: BIS; Bloomberg; IMF and RBI staff estimates. References: A formal panel logit regression for the sample of AEs and EMEs indicates that the probability of a hard landing Bank for International Settlements (2022), BIS Annual increases if the tightening is preceded by high inflation, Economic Report 2022 (Box 1 C: “How Likely is a Soft high GDP growth and higher increase in credit/GDP Landing?”). ratio; higher real policy rates prior to the start of the Blinder, A., (2022) “On Landings Hard and Soft: The tightening episode, on the other hand, appear to reduce Fed, 1965-2020”, Lecture at Markus’ Academy, February, the probability of a hard landing by mitigating the build- available at https://bcf.princeton.edu/events/alan-blinder- up of financial excesses (eq. 1). on-landings-hard-and-soft-the-fed-1965-2020/. Probability (Hard landing) = -3.99 + 0.31 CPI +0.30 GDP – 0.15 RPR + 1.34 Credit t t-1 t-1 t-1 t-1 ................ (1) (0.000) (0.004) (0.056) (0.021) (0.100) CPI, GDP, RPR and Credit refer to 4-quarter averages of consumer price inflation, real GDP growth, real policy rate and change in credit/GDP ratio, respectively. Figures in parentheses are p-values. Source: RBI staff estimates. 4 Hard landing for the purpose of this analysis is negative GDP growth rate (y-o-y) for 2 or more successive quarters for AEs; for EMEs, it is a fall in GDP growth rate by 60 per cent (or more) for 2 or more successive quarters from the average GDP growth rate over the sample period. A soft landing, on the other hand, is a scenario of no recession within three years of a tightening cycle in which the policy rate is raised for at least three successive quarters and peaks. 5 One year prior to the start of the tightening cycle. 6 Average quarterly change in credit growth during one year preceding the tightening cycle. 8899Monetary Policy Report September 2022 a cumulative hike of 300 bps in the current tightening raised their policy rates by 175 bps and 150 bps, phase. It also unveiled plans for quantitative tightening respectively in 2022 while the Central Bank of Iceland to reduce its balance sheet by US$ 47.5 billion per and the Czech National Bank effected cumulative month during June-August and US$ 95 billion per hikes of 350 bps and 325 bps, respectively (Chart V.5a). month from September. According to the Summary Sveriges Riksbank (Sweden) has increased the policy of Economic Projections released in September 2022, rate by 175 bps in 2022 so far, including 100 bps hike the median federal funds rate is seen at 4.4 per cent by in September 2022. Amongst the AEs, the Bank of end–2022 and 4.6 per cent by end-2023. Japan (BoJ) remained an outlier as it maintained an accommodative stance and kept the monetary policy Amidst raging inflationary pressures, the ECB in parameters – key policy rates and the quantum of its June 2022 meeting decided to end net asset asset purchases – unchanged in 2022 so far. purchases under the Asset Purchase Programme (APP) as of July 1, 2022 while continuing to reinvest Amongst EMEs, the People’s Bank of China (PBoC) maturing securities under its Pandemic Emergency adopted an accommodative monetary policy stance Purchase Programme (PEPP) until atleast the end of effecting 25 bps and 50 bps cuts in the reserve 2024. The ECB undertook frontloaded rate hikes of requirement ratio for most banks and smaller banks, 50 bps in July and 75 bps in September in response respectively, from April 25, 2022, which injected 530 to soaring inflation. Continuing with the tightening billion yuan into the economy. It reduced the 1-year cycle that started in December 2021, the Bank of Loan Prime Rate (LPR) by 5 bps in August, the 5-year England (BoE) raised its policy rate in the May and LPR by 15 bps and the 1-year medium-term lending June 2022 meetings by 25 bps each followed by 50 bps facility loans and 7-day reverse repurchase agreements in August and September each which took the Bank by 10 bps each. Rate to 2.25 per cent. Simultaneously, in September, In contrast, most other EME central banks continued the committee unanimously voted to reduce around with policy tightening. Amongst BRICS, the Banco £80 billion in its stock of gilts over twelve months7. Central do Brasil followed up on its 100 bps rate Alongside the start of the gilt sales programme, the hike action of March with a 100 bps rate hike in May BoE also decided to launch a new Short Term Repo and 50 bps rate hikes each in June and August. It, (STR) facility to help ensure that short-term market however, paused its tightening cycle in its September rates remain close to the Bank Rate. meeting. The South African Reserve Bank raised Other major AEs have also started unwinding its policy rate by 50 bps in its May meeting and by their pandemic-led stimulus and normalising their 75 bps in both its July and September meetings monetary conditions. The Bank of Canada has raised (Chart V.5b). Amongst Asian EMEs, the Bank of its policy rate by 275 bps since April – 50 bps each in Thailand and the Bank Indonesia embarked on a April and June, 100 bps in July and 75 bps in September, tightening cycle by hiking 25 bps each in August 2022, along with quantitative tightening to maintain price followed by a hike of 25 bps and 50 bps, respectively, stability. The Reserve Bank of Australia has increased in September. In Latin America, the central banks its cash rate target by 225 bps since May – 25 bps in of Mexico, Chile and Peru continued with monetary May and by 50 bps each in June, July, August and tightening. Amongst European EMEs, Hungary has September. The Norges Bank and the Bank of Korea 7 In light of the significant re-pricing of UK and global financial assets, the BoE announced on September 28 that it would carry out temporary purchases of long-dated UK government bonds on whatever scale necessary to restore orderly market conditions. Concomitantly, the BoE decided to postpone the planned gilt sales under £80 billion stock reduction programme, that were due to commence in early October, to October 31. 9900Chapter V External Environment Chart V.5: Policy Rate Changes – Select Major Economies a: Advanced Economies b: Emerging Market Economies Source: Bloomberg. cumulatively increased the policy rate by 860 bps V.4 Global Financial Markets since April, including 200 bps in an off-cycle meeting Global financial markets remained nervous during in July. April-September as they grappled with protracted The Bank of Russia switched gears in H1 as price and geopolitical tensions, the highest inflation rates in financial stability risks subsided. It had increased its decades in many economies, aggressive monetary key rate by 11.5 percentage points in February 2022 tightening and global recession concerns. Bond yields in two steps to stem depreciation and inflationary have firmed, equity markets have corrected and the pressures amidst the geopolitical upheaval. As US dollar has surged on hawkish Fed statements and depreciation pressures waned, it cut its policy rate by safe haven demand while EME currencies broadly 12.50 percentage points since April – including by 300 weakened. bps each in two off-cycle meetings held in April and In equity markets, the US S&P index plunged beginning May, thus offsetting the rate hikes in February. The April 2022 as uncertainty regarding the pace of central bank of Turkey cut its key policy rate by 100 unwinding by the US Fed along with mounting growth bps each in August and September meetings, even as concerns rattled investor sentiments. The short-lived inflation skyrocketed to 80.2 per cent in August. rebound in the first half of June was reversed by Overall, during 2022, central banks’ rate hikes have September on account of the large rate hikes by the been quite aggressive by historical standards. In a Fed. With some dissipation in uncertainty and falling sample of 31 central banks (13 AEs and 18 EMEs) that inflation expectations, US equities gradually rebounded raised their policy rates in 2022 (till September 28, in July but shed gains in August and September as the 2022), 23 central banks have raised their policy rates Fed continued with its aggressive rate hikes. Overall, by 75 bps or more. Out of these, 8 central banks raised the US S&P index fell by 17.9 per cent between end- rates by more than 100 bps. March 2022 and September 28, 2022. 9911Monetary Policy Report September 2022 Chart V.6: Equity Markets a: Equity Indices (MSCI) b: Change in Equity Indices Sources: Bloomberg; and RBI staff estimates. European stock markets broadly mirrored the US of higher rate hikes. Recession concerns pulled markets, inching down in April and May on account down long-term bond yields in July, but yields edged of mounting recession fears and worries over higher during August-September on expectations surging bond yields. After a short reversal in late- of further monetary tightening. In April, the US 10- May and early-June, markets have been weighed year treasury yield raced up to a 3-year high as the down by rising inflation fears, soaring energy prices, market priced in more aggressive Fed tightening gloomy business activity data and larger rate hikes than previously anticipated. With short-term rates by the ECB. The UK stock indices also tracked also rising sharply, the yield curve became flatter. global cues. The Japanese market outperformed its As the growth outlook dimmed and recessionary peers on stable inflation and the continuation of fears rose, the short end of the yield curve hardened ultra-accommodative monetary policy to support while long-term yields softened, causing yield curve economic recovery. However, it fell to a 3-month low inversion in July. The US 10-year yield, however, in September 28, 2022. hardened again in August-September with stronger- EME stock markets underperformed developed than-expected payrolls data, hawkish commentary markets in Q2:2022 as growing inflationary pressures, from the Fed Chair and FOMC members and third recession fears, and monetary tightening in the major consecutive 75 bps rate hike by the Fed (Chart V.7a). AEs impacted investors’ sentiments (Chart V.6a). In The UK and German 10-year bond yields tracked the Q3:2022, stock markets, especially for EMEs, posted US markets. The UK 10-year bond yield shot up by negative returns with Brazil and India being exceptions. 70 bps in the week ending September 28, on account The dash for safe haven led to portfolio outflows and of expansionary fiscal policy involving sweeping tax downward pressures on equities (Chart V.6b). cuts. Differing from peers, Japanese bond yields were Sovereign bond yields across major AEs hardened in range bound, given the continued accommodative Q2 and Q3 over surging inflation and expectations monetary policy stance. However, the 10-year yields 9922Chapter V External Environment Chart V.7: Bond Yields a: 10-year Sovereign Bond Yields in Select AEs b: 10-year Sovereign Bond Yields in Select EMEs Source: Bloomberg. hit the upper limit of the BoJ’s implicit band around tightening as well as global cues (Chart V.7b). Chinese its 0 per cent target in September on account of sharp and Brazilian bond yields, however, softened rise in inflation and capital outflows, prompting BoJ modestly on their monetary policy actions. to buy more bonds than planned. In the currency markets, the US dollar strengthened Bond yields in major EMEs have moved with a further against major global peers in Q2:2022 hardening bias driven by domestic monetary and Q3, reflecting the faster pace of rate hikes Chart V.8: Currency Movements and Capital Flows a: Currency Indices b: Portfolio Flows to EMEs Note: The data for portfolio flows to EMEs is weekly. Sources: Bloomberg; and IIF. 9933Monetary Policy Report September 2022 and quantitative tightening plans relative to other V.5 Conclusion major AEs (Chart V.8a). Rising safe haven demand The risks to the global growth outlook are amidst the ongoing geopolitical upheaval and overwhelmingly tilted to the downside as monetary soaring energy prices have further strengthened the authorities undertake aggressive tightening to rein US dollar. The US dollar’s strength was mirrored in the weakening of EME currencies amidst ebbing in high inflation. The uncertainty around the war investor interest. Capital outflows during March-July and the pace of monetary tightening going ahead exacerbated the volatility in EME currencies. Capital are imparting sizeable volatility to global financial flows resumed in August but the trend reversed in markets, while also lending safe haven demand to the September led by equity outflows (Chart V.8b). The US dollar. These developments are generating large MSCI Emerging Market Currency Index declined adverse spillovers to emerging market economies by 4.4 per cent in Q2:2022 and by 5.4 per cent in and posing sizeable downside risks to their growth Q3:2022 (up to September 28, 2022). prospects. 9944