The newly constituted Monetary Policy Committee adopted on Friday (October 9) a policy stance that offered dollops of hope instead of the usual tangibles that one expects from the Reserve Bank of India (RBI).
Governor Shaktikanta Das had nothing to offer on the repo — the base rate in the economy, at which the central bank lends to other banks — front. Instead, he promised a range of goodies to promote the feel-good feeling as India heads into the festive season while the economy battles its slowest-ever slowdown since Independence.
With inflation above the target set for itself, nobody seriously expected the RBI to reduce the repo rate from the 4 per cent level it was at; as expected, therefore, the MPC did not change the floor rate. Instead, a flurry of announcements came, all broadly in keeping with the Narendra Modi government’s approach to the economic crisis unleashed by the pandemic since March.
The easy liquidity mantra
Friday’s policy statement continues an economic policy trajectory that has been in place since Covid-19 hit India. A striking feature of the government’s response has been to offer liquidity support to wide swathes of industry and services that have collapsed or on the verge of collapsing in the crisis. Significantly, this has been mediated by RBI, which has passed the buck on to commercial banks.
This has failed to provoke a recovery, for several reasons. Foremost among them has been the banks’ unwillingness to lend. Banks fear that their books, already saddled with bad loans, would be splashed in red with even more bad loans. Indeed, the liquidity infusion that has happened earlier has failed to spark a sustained momentum that would generate fresh investment and growth.
In fact, there is wide apprehension that a significant portion of the infusion has entered the stock market. What else can possibly explain the spectacular increase in share prices even as the economy is as dead as a dodo? Not surprisingly, the stock markets reacted positively to Friday’s announcement of the MPC’s deliberations.
The latest policy stance of the central bank unveiled on Friday continues that same approach. The MPC has promised to open the liquidity tap even further, addressing specific sectors such as housing. The only difference is that there have been embellishments, which are not normally characteristic of such announcements. The most significant aspect of the announcements relate to the RBI’s planned intervention in the bond market, in order to keep the liquidity tap running.
These pertain in large measure to the manner in which it has revealed its readiness to cooperate with the Union Government in its borrowing programme during the current year. Additionally, the central bank has announced that for the first time it would buy bonds issued by states as part of their borrowings, apart from significantly expand its overall scale of Open Market Operations (OMO) in the bond market.
Supporting the government’s borrowing programme
When economic entities — including the government — need fresh borrowings, they issue bonds. The RBI has assured its willingness to buy these bond issues. This is not small by any means. The massive borrowing programme of the Centre and the states is expected to amount to ₹21.6 lakh crores in the current year. And, if the Modi regime does actually plan a fiscal stimulus later on, it could rise even higher. Of course, an even sharper contraction on the tax front could also cause borrowings to increase even further.
A worrying feature of the bond market since the pandemic commenced is the rising interest rates on bonds. For example, soon after the lockdown Kerala’s initial borrowings were at the alarming level of almost 9 per cent. Although interest rates have softened since then, the bond markets have also been swayed by the possibilities of a deterioration on the inflation front; after all, inflation eats into the real returns that investors make in bonds. Thus, the RBI, while acting as a willing accomplice to the government in its borrowing programme, has also to ensure that the interest rates remain within manageable limits. The rope trick lies in ensuring that it achieves this without abandoning its cardinal role in keeping inflation in check.
Although Das has not revealed the RBI’s OMO calendar, it has announced that state loans will be part of its operations. Moreover, it has eased limits on the extent to which banks can invest in bonds. This has been done primarily by easing the norms governing the deposits lodged with them. Effectively, this raises their ability to invest in bonds, which translates again to an enhanced capacity to infuse liquidity. All in all, it seems the abiding faith in liquidity appears to be the defining feature of the RBI under the stewardship of Das.
Lacklustre demand for credit
The latest move would enable banks to not only invest in debt instruments such as bonds but also allow them to lend directly to corporates. Banks are expected to have an additional capacity to borrow up to Rs. 1 lakh criers as a result of the measures announced on Friday. Although Das claimed that the move would kickstart backward and forward linkages in the economy, it is by no means certain that additional liquidity alone would do the trick.
The growth of bank credit has been sluggish despite the efforts of the Finance Ministry and the RBI to pump liquidity. Non-food credit has grown by a measly 5 per cent (as of September) during the current year. Outstanding credit in the bank credit has also fallen during this time, by a little over Rs. 1 lakh crore during this time. Moreover, bank credit to industry has barely increased by just 0.5 per cent, compared to August 2019. Indeed, most of the credit growth has been concentrated in banks’ lending to retail customers during the current year.
The new version of the Targeted Long Term Repo Operation (TLTRO) brings to mind the results of a similar exercise in April, which resulted in the “targeted” funds being cornered by a few corporates like L&T and Reliance, instead of smaller companies that needed funds more urgently. That experience ought to be chastening. There is no reason why banks would be bold enough now to lend to entities that actually need funds to revive productive activity.
RBI’s GDP forecast
The RBI, which has thus far avoided venturing to estimate the extent of the contraction, stuck its neck out for the first time on Friday. After the recent official estimate, that GDP growth had declined by 23.9 per cent, the RBI estimates that the economy is likely to decline by 9.5 per cent during the current year. It expects the contraction to be by about 9.8 per cent in the second quarter (ending September 2020), contract by 5.6 per cent in the third quarter (October-December) and finally revive marginally by 0.5 per cent in the last quarter (January-March 2021).
The RBI has clearly demonstrated its willingness to sync its policy to help the government meet its borrowing programme. This is especially critical because of the extreme strain that the Centre’s finances have come under because of the collapse of revenues since the pandemic. It has also indicated that it is on the same page as the Finance Ministry is in assuming that a liquidity boost would revive the economy.
Clearly both central actors — the Finance Ministry as well as the RBI — stubbornly refuse to address the slump in demand. The RBI’s own survey of consumer sentiment, conducted among more than 5,000 households spread over 13 large cities, reveals curtailment of overall spending, including on essentials. Although the survey reported that households expected an improvement, it is by no means certain that this guaranteed. The uncertain trajectory of the pandemic’s spread is accompanied by uncertainty about the sequence of expansion as the county “unlocks” gradually, unevenly and in fits and starts.
The policy stance adopted on Friday continues with its emphasis on liquidity. Essentially, this means that the task has been left to the banks, urging them to use “prudential” lending norms to extremely distressed customers, most of whom are on the verge of collapse. Naturally, risk-averse banks have refused to lend. That same strategy continues. And, the results are likely to be similar.