A monetary policy to pump prime growth

K Srinivasa Rao | Updated on October 13, 2020 Published on October 13, 2020

Playing the role of confidence booster   -  PAUL NORONHa

Apart from providing ample liquidity and credit growth enablers, the RBI has assured industry of support when needed

The RBI in its recent Monetary Policy review has provided an optimistic forward guidance. It predicts that inflation, at 6.69 per cent in August, will begin to recede in Q4 of FY 2020-21 and can go down to 4.3 per cent by Q1 of 2021-22 as supply side dynamics improve with the opening up of the economy. Also, it expects GDP to improve from the abysmal -23.9 per cent in Q1 of 2020-21 and to end the current fiscal at -9.5 per cent.

Instead of using rate cut as market signal, the RBI has used its market intelligence and external expertise to carve out innovative enablers and infused optimism. Reinforcing its commitment to maintain an accommodative monetary policy stance as long as it is necessary to revive growth, is a clear sign that the option of rate cut is not closed. More than such affirmation, the data backed forward view should be able to reinforce confidence in entrepreneurs to stimulate economic activities. Building upon the pulse of early signs of recovery, the RBI could well balance between priorities of growth and inflation.

Comparing early high frequency growth indicators — pre-Covid February and August data — the RBI has identified agriculture and the rural sector as a key stimulator to prop up the growth impulses. Evident rise in sales of tractors, two-wheelers, three-wheelers, spurt in agriculture exports and sale of fertilisers have demonstrated impending signs of recovery.

The eight-core industries (ECI) index improved from 60 in April to 85 by August. Increase in production of steel, cement and electricity is notable. Production of automobiles has picked up pace recording higher sales. Construction, transport and domestic trade also reflect buoyancy.

The composite Purchasing Managers’ Index (PMI) dropped from 57.6 in February to 7.2 in April has bounced back to 54.6 in August cruising fast towards pre-Covid levels. Such positive trail of economic indicators affirms the optimism of the RBI and provides a sense of confidence to markets.

Credit push

The bank credit growth trailing at 5.26 per cent year-on-year on September 11, against deposit growth of 11.98 per cent, is worrisome and needs immediate attention. Considering the constraints of banks in lending, the RBI has increased regulatory limits for retail portfolio.

The maximum aggregate retail exposure limit of banks to a single counter-party has been raised from ₹5 crore to ₹7.5 crore. It rationalised differential risk weights on individual home loans and linked them to only loan to value ratio (LTV) sanctioned up to March 31, 2022. This can create demand for high-value loans of over ₹75 lakh. The proposed reduction in risk weights is expected to save close to ₹500 crore of capital of banks.

The scheme of ‘Co-Lending Model’ for banks and non-banks introduced in 2018 has now been extended to all NBFCs, including housing finance companies. This will enable financial intermediaries to leverage comparative advantage.

Right from the outbreak of Covid-19, the RBI has been pumping liquidity — close to ₹10 trillion so far in different forms. Continuing its policy to extend sufficient liquidity support for the stability of financial markets, the RBI is actively working towards ensuring softer yield curves to rein in cost of government borrowings. While doubling the size of each auction to buy bonds to ₹20,000 crore, the RBI for the first time included state development loans under open market operations (OMOs).

The RBI has also proposed to conduct on tap Targeted Long Term Repo Operations (TLTRO) with tenors of up to three years for a total amount of up to ₹1 lakh crore at a floating rate linked to the policy repo rate that assures medium term and long term liquidity to banks. The RBI is open to increase the amount and tenure of TLTROs depending upon the response and liquidity needs.

Amid the convincing growth optimism, the RBI has created reinforcing support structures with ample liquidity, softer yield curves, credit growth enablers and, more importantly, the assurance to stand with the industry for necessary interventions to ensure that the economy recovers to pre-Covid status soon.

The writer is Adjunct Professor, Institute of Insurance and Risk Management Hyderabad. Views are personal

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Published on October 13, 2020
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