With the second wave of Covid-19 pandemic gradually subsiding and mobility restrictions easing, a recovery in economic activity is taking shape which would become more visible over the second quarter.

An accommodative monetary policy and an expansionary fiscal policy stance aimed at driving investments, rollout of vaccinations, flexible and adaptive business models leveraging on technological innovations along with a strong global economic recovery, have made for a better setting to deal with the ongoing once-in-a-century pandemic. Global economy is expected to expand by 5.6% in 2021, reckons the World Bank – making it the strongest post-recession pace in 80 years.

Based on this encouraging backdrop, India’s real GDP growth could be around 9.6% this fiscal year. The outlook on growth, however, is fraught with risks, and possibility of a third wave amidst slow pace of inoculation still imparts considerable uncertainty to future trajectory. Persistently rising inflation is another key risk to watch out for in India and among major advanced economies, which could put upward pressure on interest rates and impart volatility to capital flows and financial markets.

Domestic consumer price index (CPI) inflation has surged sharply over the first quarter and is once again above the upper threshold of the CPI inflation target band of 6%. The drivers of inflation largely remain among the food and fuel categories, indicating continuing influence of supply side pressures on price movements. Imported inflation from higher crude oil prices can also accelerate and feed into higher cost of transportation and logistics, especially in case if local taxes are not reduced. Persistent food and fuel inflation is likely to push household inflation expectations higher too, which can feed into already high core inflation. For the full year, we expect headline CPI to average around 5.70%, remaining above the 4% target for the second successive year.

Given the continuing risks of Covid-19 variants and current pace of inoculation, the monetary policy committee (MPC) would continue with its accommodative stance of sustaining growth on a durable basis. RBI, through various instruments, has infused durable liquidity worth over 8% of GDP since February 2020. Incremental normalisation is expected through introduction of longer-term variable rate reverse repo (VRRRs), followed by increase in reverse repo rate starting Q4 FY 2022. Near term domestic swap rates also reflect future funding rates inching up closer to repo rate.

Since the introduction of VRRR in January 2021 as a step towards resumption of normal liquidity management operations, an impact of 50-70 bps impact has been witnessed in the 3-7 year segment. While certain segments of the bond yield curve got anchored by RBI through GSAP (government securities acquisition programme) and active participation in benchmark securities, a gradual increase in spreads was witnessed in off-the-run securities and SDLs (state development loans). With continuing GSAP 2.0 and bond switch announcements, RBI is likely to continue the focus of yield management, in terms of absolute levels and shape of yield curve while ensuring adequate liquidity for growth revival.

Credit growth remains weak at present on asset quality concerns related to consumer credit and MSME segment and a pick-up in the near term would be muted. That said, policymakers have created a congenial environment for bank credit offtake over the medium term to support investment activity. A long-term public sector driven strategy is emerging which aims to crowd in private investment. National infrastructure pipeline is one of the key components of the strategy under which the government is aiming to achieve Rs 102 trillion in investments in energy, roads, and urban infrastructure with centre, state and private sector participation, until 2025.

Another effort on these lines is Production Linked Incentive (PLI) scheme for 13 sectors with fiscal incentives worth Rs 1.97 trillion over the next five years to increase domestic production in these critical sectors by attracting private and foreign capital. The financial sector legacy issue of the non-performing assets (NPAs) is being addressed through the bankruptcy code and formation of a bad bank. These steps should help free up capital for investments, especially in the new emerging sectors like green energy. A new financial institution has been set up for infrastructure sector which should help channelise long-term capital toward infrastructure projects, typically with long gestation period.

In summary, as the economy gets ahead of the pandemic this year, a reflation is expected to set in led by a virtuous cycle of investments.

Arun Khurana is IndusInd Bank Deputy CEO.