In times like never before, the Reserve Bank of India’s Monetary Policy Committee (MPC) has acted like never before. This is seen in two aspects – one the stuff of headlines and another the stuff of fine print that has almost been missed because of the waves created by the headlines.
The obvious big-ticket takeaway is that the MPC has announced a reduction in the policy repo rate by an unprecedented 75 basis points. This has the effect of making available ample liquidity to tide over the huge challenges that come in the wake of the COVID-19 pandemic. The reverse repo rate has been reduced even more, by 90 basis points in total. This has the effect of crafting a tilting corridor in Liquidity Adjustment Facility (LAF) so that the banking system is incentivised to draw liquidity and there is a disincentive to park overnight funds with the RBI. The logic is that the funds will go where they are needed most –- to move the wheels of an economy that globally may dip into a recession.
To quote the MPC, which actually met ahead of its schedule for this policy announcement, “The outlook is now heavily contingent upon the intensity, spread and duration of the pandemic. There is a rising probability that large parts of the global economy will slip into recession.”
Which brings us to the other “never before” by the RBI/MPC — there is no outlook provided either on growth or on inflation in India! The inflation forecast is the intermediate target in any MPC announcement. Any monetary policy decision without a forecast of inflation begs the simple question: on what is the decision based, after all? It will raise doubts on the integrity of the decision. Similarly, there is no outlook on growth for India though there is a global view of a coming recession.
This makes the policy announcement and statement highly unusual, to put it mildly. It reflects the uncertainty in the situation, the lack of clear understanding on how the pandemic may possibly play out and also points to what possibly is a very dim view of the economy that is probably best not expressed at this stage.
Along with other important measures in the policy, one may say that the RBI is focused on pushing and reviving growth. The RBI has announced a multipronged approach. One leg is targeted (Targeted Long-Term Repo Operations, or TLTRO, of Rs 1 lakh crore), coupled with a system-wide liquidity provision, i.e., reduction of Cash Reserve Ratio (CRR) by 1-3%, which will release primary liquidity amounting to Rs 1.37 lakh crore and to increase the accommodation under the Marginal Standing Facility (MSF) from 2% of the statutory liquidity ratio (SLR) to 3% with immediate effect. This measure will be applicable up to June 30. This measure should provide comfort to the banking system by allowing it to avail of an additional Rs 1.37 lakh crore of liquidity under the LAF window. These three measures, relating to TLTRO, CRR and MSF, will inject a total liquidity of Rs 3.74 lakh crore to the system.
The massive injection signals the preparedness of the RBI to address any eventuality in a possible liquidity crisis. Whether they will in any way help the revival of growth and maintaining CPI inflation at 4% average is entirely another matter. Given the magnitude of the crisis, and the unprecedented lockdown it has led to, being armed with liquidity solves one leg of the problem. The other one is, who will be ready to benefit from this liquidity? If the banks are ready to lend, who is there in the market to borrow, after all? This mismatch will continue as long as the situation does not stabilise.
The moot question is, will India also slip into recession? It would have been appropriate on the part of the MPC/RBI to make a statement on inflation and growth outlook. Without this, we are left with the vagaries of interpretation by anybody and everybody, leading to speculative attacks on the commodity and financial markets.
A rate cut of such unprecedented nature, accompanied by accommodative monetary policy, is intended to revive growth with targeted retail inflation rate of average 4%. The current scenario of rate reduction and its transmission to bank lending rate has to be seen in the context of past rate cuts. Evidence suggests that even past rate cuts and LTRO together have not been effective in rate cut transmission. In a complete lockdown situation, which sector of the economy will be engaged in the production process? On the contrary, there will be no production activity. Interest rate reduction is the least priority now for industry, agriculture and services. Some unsustainable growth revival may take place with the fiscal stimulus announced by the Union government in terms of government consumption expenditure of Rs 1.7 lakh crore.
Regarding inflation, there are fears that unscrupulous traders will jack up prices. The trend has already started. There could be some element of cost push inflation that gradually will set in. To control this, monetary policy is helpless. Another important aspect is inflation expectation, given the actual high retail inflation rate in the past three months and the present price spiral due to probable disruption in the supply chain. Food inflation will be a challenge and inflation expectation will be higher in the three months and one-year horizon.
The MPC notes that strong fiscal measures are critical to deal with the situation. This is a classic motherhood and apple pie statement. The important questions are: first, what fiscal measures? Second, does the government have fiscal space? Let the government and RBI jointly work out this. Textbook solutions of policy rate reduction to address aggregate demand management have not worked in case of rate reductions in the past and will not work now.
In which court does the ball lie currently? It is with the banks and private corporates. Private corporates should not behave like fair-weather friends. They are important stakeholders and should work for development now. So also should the NGOs. All of us should realise that aggregate demand management through monetary policy interest reduction and fiscal stimulus have limitations to revive growth. A wide range of stakeholders will have to join hands for the nation to claw out of the situation caused by the pandemic.
(The writer is a former central banker and a faculty member at SPJIMR. (Through The Billion Press)