Money & Banking

Repo rate cut was to deal with collapse in demand: MPC

Our Bureau Mumbai | Updated on June 05, 2020

While all members of the monetary policy committee (MPC) were on the same page vis-a-vis the need for a repo rate cut to deal with the collapse in demand due to COVID-19, one of them differed from others on the quantum, emphasising that big cuts should be saved for when the economy starts reviving, and not when the country is in a lock-down.

Chetan Ghate, Professor, Indian Statistical Institute, while voting for a 25 basis points cut in repo rate, observed that: “Rate cuts, assuming that there is transmission and banks lend, works most effectively when the economy is on the upside. The MPC should keep some gunpowder dry.”

Five members of the MPC voted for a 40 basis point cut in the repo rate (the interest rate at which the central bank lends funds to banks to help them overcome short-term liquidity mismatches) last month from 4.40 per cent to 4 per cent. The RBI on Friday released the minutes of the MPC meeting.

Referring to the reverse repo rate being cut thrice in succession to 3.35 per cent, Ghate said the idea behind the asymmetric cuts is to use the LAF (liquidity adjustment facility) corridor as an instrument of monetary policy. For all practical purposes the reverse repo rate is now the effective policy rate.

“I worry that the current quantum of liquidity will be difficult to unwind when things return back to normal. RBI’s liquidity policy has helped stabilize financial markets, but lender of last resort policies, as is widely recognised, are not useful outside a crisis, and thus should not be viewed as part of normal monetary policy,” he added.

Ease financial conditions

Pami Dua, former Director, Delhi School of Economics, said in order to revive growth and mitigate the economic impact of COVID-19, it is important to ease financial conditions further.

Dua opined: “In the current scenario, with heightened uncertainty and a near-standstill in economic activity, this (repo rate cut) may not necessarily lead to an immediate increase in borrowing, but should raise consumer confidence and investor sentiment, going forward.”

Ravindra H. Dholakia, former Professor, Indian Institute of Management, Ahmedabad, underscored that there are all symptoms of a recession – fall in aggregate demand, negative real growth and high unemployment.

“The government has provided a major fiscal boost through a series of announcements. The role of the monetary policy under such circumstances should be to supplement and support the fiscal efforts to bring the economy out of the unprecedented crisis.

“Without exhausting all the space for policy rate cuts, in this meeting I, therefore, vote for a 40 bps cut in the policy Repo Rate,” he said.

Janak Raj, Executive Director, RBI, said given the long transmission lags with which monetary policy operates, it is important to create enabling financing conditions so that economic activity takes off swiftly as soon as normalcy is restored. Should inflation trajectory turn out as expected, some more policy space may open up, going forward, he added.

He noted that: “For monetary policy actions to transmit fully to the credit market, it is important that banks remain well capitalised. Only banks with strong balance sheets could be expected to support lending activity as and when credit demand picks up.”

Nurture green shoots

MD Patra, Deputy Governor, RBI, felt that in the evolving configuration of growth and inflation, monetary policy can inspire confidence among households and businesses to break the vortex of public preference for deposits over spending and banks’ aversion to lend and invest.

“Ahead of turning to mend broken areas of activity, it is important to nurture the green shoots that have become visible – as in agriculture and allied activities – so that they take root and grow.

“These considerations warrant backing up past actions and stance with another decisive reduction in the policy rate while persevering with the accommodative stance.

“The experience of central banks has been that monetary policy acts best when it is reinforced by policy actions and stance in the same direction repetitively till the desired objectives are achieved,” Patra said.

RBI Governor Shaktikanta Das said given the enormity of a collapse in demand, the need is to move ahead full throttle to ease financing conditions further so as to revive consumption and revitalize investment.

“The benign inflation outlook that is expected for the second half of 2020-21, coupled with the rising probability of a sharper loss of growth momentum in the near-term, has provided us with more policy space to ease financial conditions further and stimulate growth.

“Since the outbreak of COVID-19, the MPC has voted for front-loading its actions. In view of the deteriorating outlook, it is critical to reinforce these actions in sync with the space provided by the underlying conditions,” explained Das.

Published on June 05, 2020

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