Further rate cuts may boost credit-led growth

Barendra Kumar Bhoi | Updated on May 22, 2020 Published on May 22, 2020

Recent quantitative easing by the RBI has not been carried forward to lending rates. There is space for another repo rate cut to 3.5 per cent

Rebooting of the Indian economy in the wake of Covid-19 pandemic, has been met with stupendous challenges. The daily count of coronavirus-positive cases is still rising, although it is linear rather than exponential. As Covid-19 vaccine is not expected soon, the only hope is India’s recovery rate, which has steadily improved to the world average of nearly 40 per cent by May 20, 2020. Lifting of lockdown restrictions based on the geographical intensity of the disease has been gradual, as the fear of a second round of infections looms large. The trade-off between lives and livelihoods needs delicate balancing.

Before the Covid-19 crisis, India witnessed a steady deceleration in GDP growth from nearly 8 per cent in 2016-17 to 7.2 per cent in 2017-18, 6.1 per cent in 2018-19, and further to 5 per cent in 2019-20, mainly due to the slowdown in exports and sluggish gross fixed capital formation. Amidst a sharp slowdown in private investment, the Indian economy was somehow running based on domestic consumption, until the Covid-19 outbreak in March 2020.

India’s consumption demand has suffered a major setback due to loss of livelihood of millions of people following repeated extensions of nation-wide lockdown. Relief measures are typically small and last for a while, and therefore cannot sustain regular consumption demand needed to reboot the economy. People need to remain employed, failing which consumption cannot be sustained through relief for a long time.


Credit push

The government’s announcement of a ₹20-trillion ‘Atmanirbhar’ package so far has a small element of relief, but a big component of it relates to rehabilitation, which is largely credit-led. This is expected to protect the livelihoods of a large section of society, particularly in the unorganised sector. Although the government could not provide big stimulus to pep-up consumption demand due to limited fiscal space, the structural reforms proposed, covering wide areas — agriculture, industry, infrastructure, mining, etc — would create employment opportunities going forward, provided the proposals are implemented in a time-bound manner.

In the case of an unprecedented crisis like the Covid-19 pandemic, both fiscal and monetary policies should be accommodative, the relative role depends on the availability of policy space. The blueprints of both the public policies outlined so far have been exemplary and need to be implemented through careful coordination. While hurdles in the real sector need to be removed by the government, the financial sector’s problems should be resolved by all regulators, led by the RBI. One of the major hurdles in the financial sector has been the availability of credit at globally competitive rates.

Before the Covid-19 crisis, credit conditions in India were tight, largely due to the NPA problem of banks/financial institutions and weak balance sheets of borrowers, particularly in the manufacturing sector. Consequently, banks have been extremely risk-averse. Demand for credit has also slowed down following deceleration of growth. In the wake of the Covid-19 crisis, there is a need to persuade banks to shed their risk-averse attitude and simultaneously assure borrowers a low-interest rate regime for a considerable period.

Lowering rates

The policy rates of many advanced central banks are currently near zero. Although it is not advisable for RBI to reach zero lower bound, there is enough space for a further repo rate cut, say to 3.5 per cent, close to many developing countries (See Table). As monetary policy transmission has long and variable lags, there is a case to re-regulate lending rates, at least for a couple of years to tide over the current crisis. The intermediation cost of money borrowed from the RBI is the least. There is no need for banks to maintain CRR on this liability.

The government has promised to take the credit risk under the credit guarantee scheme for MSMEs. Hence, banks should refrain from being risk-averse anymore. The recent quantitative easing by the RBI has not been successful in reducing the lending rate appreciably. Liquidity made available to banks for at least three years at 3.5 per cent should reach the ultimate borrowers at a lending rate not exceeding 5.5 per cent. Repo-linked lending rates may be handy in this situation.

Modalities can be worked out whether the RBI should lend through LTRO/TLTRO, large-scale OMO purchases or refinancing. Similarly, the amount should be split between big and small borrowers and may be deployed through loans and investments in each category. Interest on outstanding LTRO/TLTRO funds may also be reduced to give an opportunity for the credit-led ‘Atmanirbhar’ scheme to be successful.

The writer is a Visiting Fellow at IGIDR and former head of the RBI’s Monetary Policy Department. Views are personal

Published on May 22, 2020

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