Securing livelihoods: What more can the RBI do?

In its latest initiative, the Central government has announced the ‘Atmanirbhar’ package, aimed at rehabilitating and rebooting the economy.

The RBI has played a key role so far by announcing several emergency measures, such as: deep cut in policy repo rate/reverse repo rate; releasing record level of liquidity by cutting CRR, exempting SLR, purchasing government securities under long-term repo operation (LTRO), targeted LTRO for corporates, NBFCs, MSMEs, MFIs, sector-specific refinance to NADARD, SIDBI and NHB, special liquidity facility for mutual funds; and regulatory forbearances for both lenders and borrowers .

The system level surplus liquidity, measured by net reverse repo outstanding, was ₹8.5 trillion as on May 5, 2020.

It is too early to evaluate the outcome of the RBI’s initiatives as lockdown conditions remain alive in critical financial centres of the country, particularly in red zones. One would expect the initiatives to be fruitful as soon as normalcy is restored. What more can the RBI do going forward?

Monetise deficit?

Many experts have suggested that the RBI should monetise the deficit as the financial market is unlikely to absorb the burden of enhanced borrowing programme without raising the yield. Although an escape clause exists for monetisation, it would be a retrograde step if pursued as the last resort, having implications on India’s sovereign rating. Further, it is not a desirable option in the flexible inflation- targeting regime. Short-term compulsions should not compromise the long-term interests of the nation. The government has not violated this principle in the Atmanirbhar package.

As of now, LTRO, TLTRO, sector-specific refinance, special liquidity facility for MFs and large WMA (₹2 trillion for the first half) are outside the RBI’s normal liquidity management operations. Even deep cuts in CRR and SLR exemption facilitate enhancement of the systemic liquidity. Large increase in net RBI credit to the government during a year, beyond what is necessary for the normal liquidity management, tantamounts to implicit monetisation of debt, without violating direct participation of the RBI in the primary issuances of sovereign papers.

Covid bond

In case of need, as an adviser to the government, the RBI may suggest a Covid-19 bond in foreign currency to be floated in overseas markets. This bond may be tax-free to get subscriptions at a finer rate and opened to all non-residents, including NRIs, for an amount of about $15 billion. A similar amount can be arranged under activating bilateral swap arrangement, wherever possible, besides negotiating maximum possible amount from multilateral institutions like the IMF, the World Bank and ADB.

These arrangements can make good the outflow of foreign exchange due to flight to safety and smoothen the liquidity management going forward, particularly when temporary liquidity measures expire.

Due to huge excess liquidity at the system level, the reverse repo rate (3.75 per cent) has emerged as the effective policy rate. Hence, it is desirable to reduce the repo rate by 65 basis points (bps) in the June policy so that RBI’s liquidity is available to banks at a cheaper rate, enabling banks to reduce lending rate without drastic reduction in deposit rates. Moreover, the corridor may be restored to plus/minus 25 bps, which means a cut of both MSF and reverse repo rate by 65 bps and 25 bps, respectively. This would obviate the criticism of the RBI taking interest rate decision outside the MPC framework.

In order to discourage banks from depositing huge amounts of money with the RBI at fixed rate under collateralised reverse repo, a cap may be set for such deposit at 1 per cent of each bank’s net demand and time liabilities. The remaining amount may be accepted under a standing deposit facility, to be operationalised by the RBI, at a very low rate, say around 2 per cent.

Growth projections

In order to justify a further deep repo rate cut, the RBI should give its best projections on growth and inflation in FY21, which it skipped in April 2020. Its earlier growth and inflation projections have been way off the mark under certain occasions. Not giving any projection does not serve any useful purpose; it also complicates communication.

There may be a need for tweaking/extending regulatory forbearances as the lockdown has been extended. Moral suasion apart, the time limit for the use of TLTRO funds may be extended up to 90 days as corporates had little time to complete the formalities needed to issue debt instruments/commercial papers/non-convertible debentures due to the lockdown.

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

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