Opinion

The RBI has risen to the occasion

Himadri Bhattacharya | Updated on March 29, 2020 Published on March 29, 2020

The repo rate cut by the RBI’s MPC, along with the measures to enhance liquidity and stabilise the rupee, can help in easing the economic fallout of the Covid-19 pandemic

In line with what many other major central banks have been doing in the face of the unprecedented economic blow caused by the outbreak of Covid-19, the RBI unveiled an extra-ordinary set of monetary and regulatory easing measures on Friday aimed to ensure financial stability and to put the economy on a steadier footing. These measures, for which the RBI used all the relevant tools at its disposal, are also intended to complement the fiscal package of ₹1,70,000 crore announced by the government earlier in the week, and possibly to support its borrowing programme for the next fiscal year.

That the Monetary Policy Committee of the RBI, whose first bi-monthly meeting for 2020-21 was advanced by a week, would announce a steep cut in the policy repo rate was widely anticipated by the financial markets. But to what extent the 75 basis points easing and the fresh liquidity injection to the tune of ₹3.74 lakh crore will help reverse or even control their strong pessimistic and bearish undertone is still uncertain.

The prospects and outlook for the Indian economy is, as like the case globally, in the words of the MPC “heavily contingent upon the intensity, spread and duration of the pandemic.” It is too early now to foresee how things will shape up even six months down the road, even though it is apparent that the odds indicate a significant downside. Such an uncertain phase for the world economy, for which a recession in 2020 is now a distinct possibility, has not been witnessed in the living memory. The financial markets are only reflecting this reality.

Enormous challenges

The enormity of the challenges currently faced by the RBI and the heft of its response thereto can be gauged from the fact that the repo rate cut comes on the top of a cumulative rate slashing of 135 basis points in 2019, taking the real interest rate into the negative territory. The planned liquidity infusion, together with the ₹1.60 lakh crore of liquidity already created in the month of March by way of long-term repo and open market operations, will amount to about 2 per cent of India’s GDP.

Already, the RBI’s push for higher liquidity is manifest in the rate of expansion of Reserve Money (RM) in the recent weeks: during March 1-20, RM rose by 3.56 per cent as against its growth by 7.4 per cent in the 10 months of the current fiscal year till February-end.

The moot question now is whether the rate cut will stimulate credit growth, which was lacklustre even before the Covid-19 outbreak. Unlike in many other countries, the Indian economy has been on a downturn for over a year due to weak consumption demand and private investment growth. The constraints of credit expansion in the present situation will mainly arise out of labour, logistics and order constraints. The MSME business units that are facing difficulties due to severe dislocation of labour will be slow to resume activities significantly. Further distress in the MSME sector not only forebodes ill for the banking system, but will have serious macroeconomic and social implications.

Similarly, it is uncertain if the formidable amount of fresh liquidity infused will eventually reach the financial sector entities that need it most — the NBFCs. Earlier attempts to ease the liquidity difficulties faced by even the well-functioning NBFCs in the wake of the IL&FS default and DHFL collapse didn’t bear fruit in any meaningful way. One measure announced in this policy has, among other useful impacts, a higher chance of success in this regard as well.

Targeted LTRO

A new mechanism for liquidity infusion through a three-year term repo announced by the RBI is an innovative way of quantitative easing that can serve three purposes: One, it can ameliorate the selling pressure and give confidence to the market in respect of credit-sensitive fixed income instruments, viz corporate bonds, commercial papers and non-convertible debentures. Two, it can pave the way for new issuances of these instruments, which will help both non-financial corporates and NBFCs. Three, it may provide liquidity to NBFCs, MFs etc, which cannot access it directly from the RBI.

The first Targeted LTRO (TLTRO) auction for ₹25,000 crore, which was held shortly after the policy announcement, received a very good response with total bids at ₹60,500 crore. It is likely that the RBI will raise the total TLTRO amount vis-à-vis that announced in the policy at ₹1,00,000 crore. This mechanism is not only in keeping with the Indian legal framework, but is also designed to ensure that banks continue to play a pivotal role in monetary transmission and that the RBI’s balance sheet is not exposed to any undue credit and liquidity risks in its domestic operations.

In that respect, a TLTRO is better than what both the US Federal Reserve and European Central Bank did in the wake of the global financial crisis, by buying debt instruments directly from banks that held them. Needless to say, banks will be required to put regulatory capital for the additional credit risk that will be assumed as a consequence, the cost of which can be more than compensated by the rich earning potential for the portfolio of bonds purchased under TLTRO.

NDF market

The RBI will now allow banks in India that operate banking units in IFSC to participate in the offshore markets for derivative contracts in the Indian rupee, which exists in locations like Singapore, London, etc. This step, which will integrate the onshore forex market with its offshore counterpart, was overdue for quite some time. As with many other important liberalisation measures, this one has also been occasioned by a crisis.

The Indian rupee has been under selling pressure of late, and the RBI has been intervening to prevent any sharp fall . The presence of a few large Indian banks in the NDF market will provide a channel through which the RBI will be able to intervene in the offshore market with ease, as it does in the onshore market. This will significantly enhance the effectiveness of intervention since, quite often, both positive and negative impulses for the rupee are transmitted to the onshore market from its offshore counterpart.

The MPC has done a good job in presenting an analysis of the situation arising out of the Covid-19 pandemic in a very clear and candid manner. It has shown its firm resolve to take further measures to lessen the impact and fallout of the shock now being felt. Both the domestic and global economic situations are in a state of flux and, as such, more monetary and regulatory easing measures can be expected in the months to come.

Through The Billion Press. The writer is a former central banker and a consultant to the IMF

Published on March 29, 2020

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