RBI’s Annual Report highlights the limits to its market interventions to rescue the economy

| Updated on August 26, 2020 Published on August 26, 2020

After the severe shock to consumption which has depressed consumer confidence to record lows, a recovery appears likely only if income improves

The Reserve Bank of India’s FY20 Annual Report rounds off an annus horribilis that has not only seen Covid-19 wreak havoc on the economy, but also NBFC and bank defaults deliver jolts to the Indian financial system. It is therefore no surprise that the document makes for sobering reading. The report acknowledges that the Indian economy was in none-too-great shape even prior to the pandemic, with macro indicators clearly signalling a cyclical downturn in FY19/20. Both gross fixed investment and exports were already on a weak wicket, with Government largesse on salaries and pensions managing to prop up growth. Post Covid however, the resilient private consumption engine has given way too. After the severe shock to consumption which has depressed consumer confidence to record lows, a recovery appears likely only if income improves. It is categorical in dismissing the talk of green shoots, saying that the tentative revival signalled by high frequency indicators in April/May have fizzled out by July/August.

On savings, the rebound in net financial savings from 6.4 per cent of disposable income in FY19 to 7.6 per cent in FY20 hides a sting in the tail. Rather than stemming from households investing more in financial assets, the turnaround came from their paring financial liabilities sharply, an indicator of extreme caution. Given that Covid hit the Indian economy when it was already on a weak patch and has had a far wider real economy impact than the Global Financial Crisis, the RBI thinks a structural downshift in India’s potential GDP is quite likely. It recommends that, along with ‘non-disruptive’ unwinding of stimulus, the Centre undertake structural reforms in factor and product markets. One wishes that it had expended a little more ink detailing these reforms, instead of dwelling so much on the root causes of the slowdown.

The other key takeaway for the Centre is that, if it expects the central bank to take a more direct hand in rescuing the economy during slumps, it will need to moderate its own expectations of dividend payouts from it. With the RBI being called upon to make many direct market interventions — bond purchases, accommodation to banks and emergency liquidity lifelines to distressed sectors — it ended up expanding its balance sheet size by 30 per cent in FY20. With the Jalan committee recommending that the bank regularly top-up its contingency reserves to 5.5 per cent of its balance sheet size, the RBI was forced to use the lion’s share of its income this year to pad up its contingency fund. This ₹73,615 crore transfer to the fund was instrumental in shrinking RBI’s dividend payout to the Centre from ₹1.75 lakh crore in FY19 to ₹57,128 crore in FY20. This just goes to show that the Centre can either expect the RBI to do the heavy lifting on the economy or demand a bigger pound of flesh from it. It cannot have the cake and eat it too.

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Published on August 26, 2020
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