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RBI gauges the economic impact of Covid-19

Under all circumstances, interest rates are unlikely to rise. If you are a saver, your fixed deposit rates will continue to decline

Published: 31st August 2020 12:24 PM  |   Last Updated: 31st August 2020 12:24 PM   |  A+A-

Reserve Bank of India, RBI

Reserve Bank of India (Photo | PTI)

Express News Service

The annual report of the Reserve Bank of India is a document with a wealth of information. Yes, it may be overwhelming for someone with a non-finance background. However, if you are interested in knowing about the state of the economy once a year, you can at least try reading whatever you can.

You cannot get on top of financial markets by giving yourself booster shots of knowledge. You have to build your knowledge bit by bit. Once a year, making sense of this document could help you move forward in the world of finance.Among things that are a regular feature in the annual report, one is the ‘boxes’. One such box is analysing the impact of COVID-19 on the economy. It is perhaps the first critical assessment of the economic situation by the bank. 

amit bandre

The monetary policy committee or MPC that sets the borrowing rate for us has refrained from making any prediction on economic growth or inflation earlier in August 2020.The box inserted in the annual report tries to make sense of the impact. It says in a subtle way that the economic activity reached a bottom in the quarter to June 2020. It will recover at a gradual pace with growth turning positive from the quarter to March 2021. That is ‘closer to the reality’ assessment.

If the government had not imposed lockdowns, there would have been supply shocks causing a persistent rise in inflation and a permanent loss of economic output.There are three main economic agents, the report states. These include households, businesses and the government. Usually, the three economic agents spend during the year and create a demand for goods and services in the economy. The pandemic and the lock-down enforced across the country results in a little or no spending by households and businesses.

The government is the only agent that can continue to spend and create a demand. The expenditure on building physical infrastructures like roads, bridges and defence equipment can help make the necessary economic activity. Because of the lockdown, people have to stay at home, and it reduces labour supply to businesses. That leads to a cut in production of goods and services. There are salary cuts or retrenchments that lead to loss of income for individual households. They reduce spending and cut consumption. However, limited people-to-people contact stalls the spread of the pandemic.

Under these circumstances, infections could peak now around August 2020. The overall economic output falls about 12 per cent off the potential output.There are two lockdown scenarios. The first one impacts the supply side of the economy by cutting the labour supply and productivity. The second scenario considers the increase in marginal cost besides the cut in labour supply and productivity. Marginal cost is the additional cost of producing goods and services. You can call it a variable one.

Under the first scenario, the study shows that the inflation rate falls due to a fall in demand. The production retrenchment is less severe, but demand contraction is more pronounced due to a rise in infections. When costs increase in the second scenario, companies respond to the squeeze in profits by cutting production and labour demand. Wages see a lower rise and the economy goes through a contraction.

There is also a third scenario analysis of easing the lock-down and not enforcing it vigorously. Under such circumstances, the pain is much more pronounced. There is widespread pandemic, and it peaks only in the second half of January 2021 with a slow recovery process. It can be severely damaging to the economy as there would be persistent labour shortage and supply shocks. Those would lead to a lasting impact on the inflation rate and the output gap. Inflation would remain high and economic output would continue to fall for a long time.

What does it mean? Under all circumstances, inflation remains lower than the pre-COVID period. Interest rates are unlikely to rise under these circumstances. The RBI would be more inclined to support growth over inflation. If you are a saver, your fixed deposit rates will continue to decline. If you are a borrower, you must negotiate better repayment terms with your lender. The interest rate on your loan has to be lower than in the pre-COVID period.



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