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Monetary policy may have greater space to operate. But there are limits to what it can achieve.
The dovish tone of the policy indicates not only further monetary easing, but also the use of both conventional and unconventional measures down the road to ease the economic stress.
In an unscheduled meeting, the monetary policy committee (MPC) of the Reserve Bank of India (RBI) slashed the benchmark repo rate by 40 basis points. Cumulatively, since the imposition of the national lockdown in March, the MPC has cut rates by 115 basis points. The repo rate now stands at 4 per cent. The dovish tone of the policy, as well as the RBI’s own assessment of the inflation trajectory, going forward, signals room to cut rates further. It also suggests that the committee will continue to prioritise economic activity over price management — inflation is not the challenge, growth is. The central bank also noted that the economy is likely to contract this year, though it refrained from providing an estimate. The negative growth projection doesn’t come as a surprise — though the RBI’s reluctance to offer an estimate underlines the extent of uncertainty over the state of the economy.
The question now is: Will monetary easing help? Or is it losing its effectiveness? Demand for credit is likely to remain low as, with continuing economic and health uncertainty, firms and households will postpone their decisions. Moreover, risk averse banks are likely to hold back even if there are borrowers. The challenge of ensuring liquidity flows to the stressed parts of the system will remain. Higher-rated borrowers are likely to continue to get easy funding, while lower-rated borrowers will struggle — evidenced in higher credit spreads. The credit guarantees provided by the central government for lending to MSMEs, NBFCs, MFIs could help moderate sectoral risk aversion, but only to some extent. The reaction of the bond market to the policy statement was also muted. Perhaps greater clarity over the scale of the RBI’s open market operations, and the Centre and states’ borrowing programme for the year, is being awaited. Alongside monetary easing, the central bank also extended the moratorium on paying instalments on term loans for another three months, providing further relief to borrowers, both industry and households — though this means that the extent of the stress stemming from this lockdown on the financial system will only be accurately gauged once this period is over.
The dovish tone of the policy indicates not only further monetary easing, but also the use of both conventional and unconventional measures down the road to ease the economic stress. But while monetary policy may have greater space to operate, there are limitations to what it can achieve. It cannot do the heavy lifting alone. Fiscal support is needed