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Amid the Covid-19 outbreak, a combination of monetary policy, entailing the maintenance of a proactive liquidity regime and facilitating stability in financial markets, and fiscal policy involving the provision of relief to people at the lower strata, who will lose income because of the shutdown of commercial activity, will be the best option, according to State Bank of India’s research report titled Ecowrap .
Coordinated fiscal and monetary easing is the current prescription the world over as Covid-19 cases increase outside of China, the report said.
The report observed that the arguments for the Reserve Bank of India (RBI) cutting rates have more to do with coordinated policy actions by central banks across the world. “In particular, on the monetary side, the first best option is maintaining a proactive liquidity regime and facilitating stability in financial markets through unconventional measures. The monetary stance may be eased temporarily through a rate cut by the RBI to accommodate the possible surge in liquidity demand and shock-related price increases,” said Soumya Kanti Ghosh,Group Chief Economic Adviser, SBI.
Cash notes supply
He observed that an adequate supply of cash notes to banks needs to be ensured to meet a sudden increase in the demand for liquidity.
The report emphasised that the RBI may also need to consider a degree of prudential forbearance in specific sectors such as hotels, aviation, transport, metals, auto components and textiles. Furthermore, given the risk of using currency notes in times of pandemic, incentivising digital payments further could be an effective solution.
Recipe for future problems
The report cautioned that deposit rate cuts (and hence lending rate) beyond a point are counterproductive and actually create perverse flows into liability products that offer higher interest rates. “This could always be a recipe for future problems, if assets and liabilities are not properly matched, as the experience of YES Bank shows,” it added.
Also, the pandemic shock has an embedded adverse supply shock angle as China is the supplier of many critical inputs. Hence, the report reasoned, a rate cut with no fiscal measures in the current situation will lead to asset bubble and possibly no correction in demand. Concomitantly, there is a need to revive consumer demand.
On the fiscal side, the report assessed that the nearly 30 per cent fall in crude oil prices could lower petrol prices by ₹12/litre and diesel prices by ₹10/litre in India. The additional revenue accruing to the Centre from increasing the excise duty (₹35,000-₹40,000 crore) could be spent on providing relief to people from the lower strata of society who are set to lose income because of the shutdown of commercial activity in several States, said Ghosh.
After the success of Monday’s $2-billion USD/INR sell buy swap (RBI received bids worth $4.67 billion), the RBI has announced one more round of the swap. “This is a welcome move as it will address dollar shortage and also push up the forward premia in the process. This could discourage speculation and clearly address the pounding of Indian markets with FIIs selling around $9.2 billion beginning 20th February,” said Ghosh .
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