As global central banks stepped up emergency measures over the past weekend to counter the impact of COVID-19 on economic growth, there were high expectations of the RBI following suit and slashing its policy rate. Instead, the RBI chose to announce other measures to limit rupee volatility (USD/INR sell-buy swap) and provide liquidity through long term repo operations (₹1 lakh crore). Should the RBI have followed the conventional route of rate cut ahead of the MPC meeting next month?
While slashing the repo rate after a long pause — the last rate cut was in October last year — could have boosted sentiment, it may have achieved little on the ground, by way of lowering lending rates by banks. Through 2019, while the RBI ensured ample liquidity to banks and cut repo rate by a tidy 135 bps, banks’ higher cost of funds (in particular for private banks) had dampened transmission. With deposit growth continuing to be tepid and the YES Bank crisis rubbing off on certain banks’ ability to retain deposit flows, there is limited scope for sharp cuts in deposit rates — repo rate cut or not. Also, the RBI will have to keep some of its powder dry, to tackle the evolving COVID-19 situation — with ensuing weeks critical in India to assess the extent of the problem.
Globally, central banks now have limited firepower to tackle the sharp growth slowdown. In the US for instance, after the sharp cut of 100 bps over the weekend, the Fed funds rate is at near-zero, and the Federal Reserve has already promised to boost its bond holdings by $700 billion. While the bank of Japan raised asset buying and China focussed on liquidity, Bank of England, New Zealand, Korea, Australia — have all moved to cut rates. The Indian story is no different. With the RBI’s repo rate at 5.15 per cent and inflation hovering around the 6-7 per cent mark over the past three months, real interest rates have been in the negative zone for a while now. Unless inflation falls sharply, the RBI cannot wield the scissors on its policy repo rate.
Adopting unconventional tools like the LTRO, operation twist, open market operations or CRR dispensation can help the RBI tackle the emerging problems better. The RBI had undertaken simultaneous sale and purchase of government bonds (operation twist), in recent months, which has helped in lowering yield on long term G-Secs. The RBI ensuring long term one-year and three-year repos at repo rate (LTRO) has also helped banks lower their cost of funds. The additional ₹1 lakh crore LTRO (after the ₹1 lakh crore in February) announced this week, will ensure cheaper long term money to banks. Targeted relief to select stressed sectors in the form of short term dispensation in bad loan classification or tweaking risk weights (in turn lowering banks’ capital requirement) may also be justified if the situation deteriorates sharply hereon.
Above all, much like in other countries, the onus of reviving growth will increasingly shift to the fiscal policies of the government. A coordinated fiscal stance to support growth, is critical at this juncture.
Published on March 18, 2020