The Monetary Policy Committee (MPC) members would have liked to lower policy rates to mitigate the economic impact of the second wave. But persistently high retail inflation, which averaged 6.2 per cent in 2020-21 and is estimated at 5.1 per cent in 2021-22, meant the MPC had to keep rates on hold. What Reserve Bank of India (RBI) has not been able to do in terms of interest rates, it has more than made up in the form of liquidity and forbearance to borrowers.

Without waiting for June 2021 policy, the RBI had already announced resolution framework 2.0 under which borrowers up to ₹25 crore could restructure their loans. In fact, the impact of the second wave on the informal sector and rural economy has been inordinately high. This is to do with spread of infection in rural areas and localised lockdowns. Non-essential retail stores have been shut implying no cash flow for small businesses. The RBI in May 2021 offered them an option to restructure their loans.

In the latest policy, the RBI has extended the restructuring window to borrowers who have outstanding exposures up to ₹50 crore. Needless to say, this will help even a larger number of self-employed businesses and is a welcome step. In addition, the RBI has offered a liquidity window of ₹15,000 crore for on-lending to contact-intensive sectors such as hotels, restaurants and travel. This is after extending ₹50,000 crore on-tap facility in May 2021 for the healthcare sector. An amount equal to these loans can be parked with the RBI at 0.4 per cent, higher than existing rate thus incentivising banks to disburse these loans.

The RBI had also extended ₹50,000 crore facility to financial institutions for on-lending. Now, the RBI has extended an additional ₹16,000 crore to SIDBI for on-lending to the MSME sector. All these measures will provide liquidity to sectors impacted by the pandemic.

Govt expenditure

But fiscal support will be more important. Even last year, counter-cyclical fiscal policy helped in mitigating the impact of the pandemic. For instance, the Centre increased its expenditure by more than 30 per cent to ensure more resources in the hands of people and businesses by way of building roads, rural housing and rural employment among others. The current estimates suggest, this year the aggregate spending will be similar to last year. This arithmetic will have to change to give the desired push to the economy as was the case last year when government spending increased by 2.9 per cent when private consumption and investment fell by 9.1 per cent and 10.8 per cent respectively.

This was made possible by RBI’s liquidity operations consisting of open market operations (OMOs), long-term repurchase operations (LTROs) and targeted LTROs and the recently unveiled government securities asset purchase programme (GSAP). Through these and FX (foreign exchange) interventions, the RBI has moved the banking system from a deficit of more than ₹40,000 crore in end-March 2019 to a surplus of ₹4.84 lakh crore in end-March 2020 to an even higher surplus of ₹4.98 lakh crore in end-March 2021.

As part of this process, the RBI bought government bonds of ₹3.13 lakh crore in 2020-21. It has already bought government bonds of ₹96,545 crore in first two months. An additional ₹40,000 crore will be purchased this month. In addition, the RBI announced GSAP 2.0 under which it will buy government bonds of ₹1.2 lakh crore in the next three months. The RBI is on course to buy more bonds this year than last year.

Last year, both the Centre and States combined issued securities worth ₹21 lakh crore. Even this year, this number is likely to remain elevated. Already, the Centre has agreed to compensate the States for shortfall on account of GST for which it will have to borrow an additional ₹1.58 lakh crore this year.

Hence, like last year, this year too the RBI will have to ensure liquidity conditions remain benign so that banks too can buy government bonds. A muted credit off-take will also ensure this outcome as the economic impact of the pandemic is also visible in lower demand for credit, be it working capital or term loans. Last year, for every ₹100 deposit raised, banks lent only ₹37 against it. Most of it found its way into government bonds. Credit demand may pick-up from October onwards once a larger proportion of the country is vaccinated.

It is also visible in the RBI’s growth estimates. While the central bank has lowered its GDP growth to 9.5 per cent in 2021-22 from 10.5 per cent earlier, the revised trajectory shows a downward revision in H1 to 13.2 per cent from 17.3 per cent earlier. However, the RBI has revised its H2 growth estimate to 6.9 per cent now from 5.8 per cent earlier. Some of this is in the form of pent-up demand from H1. But a large part of demand revival will sustain in H2.

Private demand, which has been impacted due to the pandemic, will see a sustained revival, in particular that of services. Notably, half of consumption is on account of services, which have been impacted. Exports will continue to see an upward trajectory as the global economy has rebounded much faster than India. Even now, exports are already 8 per cent higher over a two-year horizon, implying they have already defied India’s pandemic-induced slowdown. Non-oil-non-gold imports, the barometer of domestic demand, are only lower by 3 per cent in May 2021 over a two-year horizon. This also goes to show that impact of the second wave on the economy is far more limited than the first wave when the same fell by more than 40 per cent in April-May 2020.

Thus, the RBI has created conditions for a smooth transition to a post-pandemic world. While it has done an excellent job in navigating through the crisis, it will have to work harder next year to normalise policy before the global monetary cycle starts turning.

The writer is Chief Economist,

Bank of Baroda

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