Indian government consumption will support current economic demand while private consumption is likely to lead a recovery that takes hold after the coronavirus pandemic eases, the central bank said on Tuesday.

June-quarter GDP data set to be released at the end of August is expected to show a contraction of 20%, according to a Reuters poll.

“An assessment of aggregate demand during the year so far suggests that the shock to consumption is severe, and it will take quite some time to mend and regain the pre-COVID-19 momentum,” the Reserve Bank of India (RBI) said in its annual report.

“Going forward, government consumption is expected to continue pandemic-proofing of demand.”

Private consumption will come back gradually with non-discretionary spending leading the way, until a durable increase in disposable incomes enables discretionary spending to catch up, the bank added.

“The upticks that became visible in May and June after the lockdown was eased in several parts of the country appear to have lost strength in July and August,” the bank said.

This weakening was mainly due to reimposition or tougher imposition of lockdowns, suggesting that contraction in economic activity was likely to be prolonged into the second quarter, it added.

Key downside risks to growth are wider pandemic spread, a deviation of seasonal monsoon rains from the predicted normal volume and global financial market volatility, the bank said.

It called for the banking sector to be freed of a risk aversion that is impeding the flow of credit to productive sectors and undermining banks’ role in the economy.

Despite a reduction in bad loans in March 2020, the banking system’s resilience will be tested by the economic fallout of the pandemic, since measures to alleviate it had masked the consequent build-up of stress in the system, the bank said.

“Against this backdrop, a recapitalisation plan for public and private sector banks assumes critical importance,” it added.

In a separate report, the RBI had warned that banks’ bad loans could nearly double by the end of this fiscal year, while the capital adequacy ratio could fall to 11.8% in a severely stressed situation.

The RBI’s balance sheet increased 30.02% by June 30, it added.

India’s rupee pulled back slightly on Tuesday after surging as much as 1% a day earlier on reports of a halt in central bank intervention aimed at keeping a lid on gains for the currency to support a struggling economy.

In a morning of trade dominated by gains for heavily export-linked markets on signs of some progress in US-China trade discussions, the rupee stood out with a small dip against the dollar.

But, having taken a beating in the past year from an economic slowdown and the world’s third worst coronavirus outbreak, dealers said the Reserve Bank of India’s surprise disappearance as a seller of the currency on Monday had fuelled speculation of more gains ahead.

By midday in Mumbai it was trading around 74.4 per dollar, just off levels below 74.2 which were its highest since mid-March. “Overall, the Indian rupee will catch up with Asian peers and there is a possibility of 73.60 in coming sessions,” said Rahul Gupta, head of Research-Currency at Emkay Global Financial Services.

Indian shares closed just shy of their six-month highs on Tuesday, powered by a rally in private-sector banks as more businesses resumed operations after lockdowns and hopes of a treatment for COVID-19 brightened.

The NSE Nifty 50 index ended 0.05% higher at 11,472.25, while the benchmark S&P BSE Sensex was up 0.12% at 38,843.88.

“Going ahead, the RBI cannot be taken for granted.” The rupee has the backing of a healthier trade account and substantial foreign investment inflows, but its gains have been limited by what traders say have been weeks of selling by the RBI. Despite foreign investor inflows of $3.9 billion year-to-date into India’s stock markets, the rupee is down about 4.1% in 2020, making it one of the worst performing in the region. India on Sunday issued guidelines for restarting its entertainment industry even as total infections crossed 3 million.

“The reopening of industries is signalling that things are coming back to normal,” said KK Mittal, investment adviser at Venus India Asset Finance in New Delhi. “Domestic markets are being driven by ample liquidity within the global system. Global cues are also supportive, with positive news coming from the COVID-19 treatment front.”

Reuters