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Priming Monetary Policy for the Pandemic
In response to a once-in-a-century pandemic in which a health crisis rapidly mutated into a macroeconomic and financial shock, the Reserve Bank of India mounted an unprecedented policy response. While the entire response involved an intertwining of monetary, regulatory, and technological measures, this paper focuses on monetary policy initiatives. Distinguishing between conventional and unconventional policy measures, the paper makes an impact assessment in terms of key macroeconomic and financial variables. The lessons drawn from this unique experience are evaluated, with emphasis on framework flexibility, the critical role of communication in anchoring expectations under extreme uncertainty, and the approach of strategic restraint in the face of a normalisation/ tightening bandwagon across advanced and emerging countries. The paper concludes by peering into the near future in which India prepares to manage the spillovers from divergent monetary policies across the world and geopolitical tensions.
The views expressed in this paper are those of the authors and do not represent the views of the Reserve Bank of India. The authors are grateful to K M Kushwaha and Joice John for their assistance and an anonymous referee for their comments/suggestions on an earlier version of the paper.
The catastrophe of the coronavirus (COVID-19)1 has caused a once-in-a-century watershed in the evolution of the world with all its constituents—continents, countries, and people—unspared as it rapidly metamorphosed from a public health crisis to a macroeconomic and financial crisis not witnessed before. Much has been said and written about the loss of life and well-being, lockdowns, and the loss of livelihood as recurring waves of the pandemic continue to shape the foreseeable outlook. COVID-19 has permanently scarred the national psyche of all countries. On 11 March 2020, the World Health Organization’s (WHO) declaration of COVID-19 as a pandemic triggered panic. In India, domestic financial markets plunged into a state of seizure, with liquidity drying up amidst extreme risk aversion and heightened volatility. Consequently, the flow of financial resources—the lifeline of the economy—choked up and, compounded by mass migration, economic activity came to a grinding halt. In fact, India suffered arguably one of the deepest contractions in the world in April–June 2020, with the real gross domestic product (GDP) shrinking by 23.8%.2 Although the evidence is still being evaluated, the anecdotal assessment is that India suffered the most grievous losses in the world in 2020 with most of it never to be recovered.
While some advanced economies (AEs) may have reached or exceeded pre-pandemic levels of output by the end of 2021, middle-income emerging market economies (EMEs)—particularly the low-income countries—have suffered large output losses. In India, recovery commenced towards the close of 2020 as the first wave of infections ebbed, only to be interrupted by a second wave in early 2021 and a third wave towards the year’s close. By 2021–22, the Indian economy will have reached barely 1.8% above the pre-pandemic level of GDP. In fact, the economy was already in a downturn in 2019–20 prior to the pandemic, with the level of GDP having slowed to its lowest rate of 3.7% in the current GDP series (base year: 2011–12).
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