India’s Monetary Policy Response to COVID-19
The COVID-19 crisis brought along with it an unprecedented shock for the economies of the world, as well as the fear of entering a global recession. The Indian Economy was facing issues on the growth front on account of the slump in private investment and consumption. According to the Monetary Policy Committee report of December 2019, without government final consumption expenditure the GDP growth would have been a mere 3 per cent. The current crisis has further worsened the scenario, with a highly uncertain inflation trajectory and a slump in growth. The pandemic would undoubtedly have a cascading effect on the economy, with an effect on credit creation, liquidity in the economy, production, in addition to the ongoing supply-side disruptions.
The RBI has undertaken a series of liquidity and regulatory measures to provide some relief to the economy with a great emphasis on liquidity infusion and lowering the cost of funds to spur credit creation announced on 27 March 2020, 17 April 2020 and 22 May 2020 besides the other notifications being issued time and again.
The RBI has the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent while supporting growth. The flexible inflation targeting framework was adopted taking into account the suggestions in ‘The Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework’ (2014). The monetary policy stance in the last fiscal year has been accommodative throughout accompanied by expansionary policy measures, while effective policy transmission has been a concern. Under the current scenario where the growth concerns are highly fragile, while inflation although uncertain is expected to remain under control, liquidity infusions are the need of the hour to steer the economy on a path of revival. The RBI extensively uses the repo and the reverse repo rates under the liquidity adjustment facility (LAF) to control inflation. In addition to that a range of Open Market Operations (OMOs) and Targeted Long-Term Repo Operations (TLTRO) are undertaken to infuse (and absorb) liquidity in (from) the economy as and when required. Purchases of bonds/ securities are conducted when the market is in need of liquid funds and vice versa.
Liquidity Injection Measures
The cumulative repo rate cut of 115 bps LAF since April 2020, reduced it to an all-time low of 4 per cent, while the reverse repo rate post three cuts now stands at 3.35 per cent. The idea behind the asymmetrical rate cuts was to use the LAF corridor as a monetary policy tool, making it unattractive for banks to passively park their funds with the RBI.
Furthermore, the RBI has conducted several Targeted Long-Term Repo Operation (TLTRO) auctions. As per the policy statement, “During 2020–21 (up to May 20), ₹1,20,474 crore was injected through open market operation (OMO) purchases and ₹87,891 crores through three targeted long-term repo operation (TLTRO) auctions and TLTRO 2.0”. The amount involved in the two TLTROs was ₹1 lakh crore and ₹50,000 crores. TLTRO 2.0 was targeted towards NBFCs. The funds availed under this measure would be deployed towards investment-grade bonds, Commercial Papers (CPs) and Non-Convertible Debentures (NCDs) of NBFCs, providing additional relief to the sector that has been suffering due to tight cash conditions. Moreover, a series of auctions called ‘Operation Twist’ that involved simultaneous sale and purchase of short- and long-term government bonds respectively. This measure has been undertaken by the RBI, even in the past in an attempt to control long term bond yields and lower the long-term borrowing rate. These measures aimed towards injecting liquidity in the system and ease monetary policy transmission.
The Cash Reserve Ratio(CRR) was also reduced to an all-time low of 3 per cent while the limit of the Marginal Standing Facility (MSF) was increased up to 3 per cent of the Statutory Liquidity Ratio (SLR), to improve bond yields and provide some comfort to the banking sector. The LCR requirement was also brought down from 100% to 80% with immediate effect on 17th April 2020 and the plan regarding restoration of the same was also announced. It was stated that the LCR requirement would be restored to the previous level in a phased manner- 90% by October 1, 2020, and 100% by April 1, 2021, providing banks with some additional funds that can be directed towards credit creation. The domestic markets have been responding to the liquidity management measures, evident from the narrowing liquidity premia and softening bond yields.
Addressing the concerns related of All India Financial Institutions, namely National Bank for Agriculture & Rural Development (NABARD), Small Industries Development Bank of India (SIDBI) and National Housing Bank (NHB) in raising adequate resources to extend credit to meet sectoral credit needs, the RBI, under special liquidity facility (SLF), extended refinancing facility of ₹25000, ₹15000 and ₹10,000 crores respectively, to ease liquidity constraints and de-stress financial markets by extending finance to small businesses, agriculture, micro-financial institutions, MSMEs etc. ₹50,000 crores under SLF was also provided to mutual funds to aid them with redemption pressures, in addition to instilling consumer confidence among fund houses.
Regulatory Measures
A series of regulatory measures were undertaken to ease the pressure on businesses and banks. On account of nation-wide lockdown and a subsequent halt in production activities, many businesses have witnessed a fall in profitability and have been struggling with their cash flows. The three-month moratorium that was later extended to six months is expected to provide some timely relief. Deferment of interest in working capital and the easing of working capital financing has also provided relief to businesses, via flushing in liquidity, enabling them to focus on revival of business and production activities amidst the pandemic, although the benefits would carry across industries. Further, to smoothen the impact for the borrowers, lending institutions are permitted to restore the margins for working capital to their original levels by March 31, 2021. The standstill on in asset classification would bring relief to a majority of debtors. As the borrowers were facing difficulty in repaying the accumulated interest for the deferment period on the working capital facility, the lending institutions are now permitted to convert the accumulated interest on working capital facilities over the deferment period into a funded interest term loan which shall be fully repaid during the course of the current financial year. The only concern lies in the ability of these institutions to pay the accumulated amount at the end of the moratorium period. The impact of heightened delinquencies is likely to surface only once the moratorium period ends.
Deferring the implementation of NSFR (Net Stable Funding Ratio) and the last tranche of CCB (Capital Conservation Buffer) by a period of six months will aid the bank’s ability to support credit requirements in the short run, and to raise new capital and address the cash-crunch problem faced by several NBFCs. These requirements are some of the capital adequacy requirements under the Basel III norms, that focus on strengthening the financial system via accumulation of funds when the economy is in a booming phase, and utilize the same in recessionary periods. Given the current crisis, it is best to relieve banks of the pressure of maintenance of such funds and divert the same towards the real sector to spur recovery and growth post the crisis.
The RBI gave Financial Institutions an additional period of 3 months to fulfil requirements of at least 75% of allotted limits under the Voluntary Retention Route(VRR), addressing the concerns of foreign portfolio investors and custodians. Set up in 2018, the VRR scheme that is free of certain macro-prudential norms applicable to other foreign portfolio investments, and aims to attract investors by providing operational flexibility. The extension is expected to enhance trading volume and scope for rupee stabilisation. A host of measures was also undertaken targeting exporters and importers who faced issues of production halts and delay in realisation cycles due to postponement of payments, by exporters and importers. While the timelines have been revised, the EXIM bank has been provided with a liquidity facility of ₹ 15,000 to boost foreign trade. The EXIM bank had been facing issues in raising funds from the international financial markets on account of the pandemic.
The debt and capital markets had been experiencing high volatility making it difficult for corporates to raise funds. The group exposure limit of banks has been increased from 25% to 30% of the eligible capital base. This will enable corporates to meet their funding requirements from banks. It will be a one-time measure and will be applicable up to June 30, 2021. Considering the impact of the pandemic on the State Government Finances certain borrowing limit relaxations were provided to ease the financial crunch. The rules governing withdrawal from the Consolidated Sinking Fund (CSF) is done prudently to enable the states to meet about 45% of their redemptions due in 2020–21 through withdrawals from CS This change will remain valid until March 31, 2021. The limit of Ways and Means Advances (WMA) of the states and UTs was increased by 60%, while that for the remaining part of the first half financial year 2020–21 i.e. April to September 2020 has been revised to ₹2,00,000 crore, helping them to bridge the gap albeit marginally, for the extra measures undertaken for emergency services for COVID-19. However, despite the undertaken measures, the combined fiscal deficit of states and centre is expected to rise massively in the current financial year, adding in concerns for effective transmission of rate cuts.
The Way Forward
The Monetary Policy Committee (MPC) in their statement said that the impact of the pandemic has turned out more acute than anticipated. Although the pandemic is a health and humanitarian crisis, the impact on the economy has been severe. The outlook on inflation is highly uncertain and the risks to growth are acute. It is now important to instil confidence and ease the financial conditions further. Also, if the inflation trajectory follows the expected path, there will be more space for economic growth. Reviving the economy would be a crucial task given the fact that the states that together contribute almost 60% to the GDP are also the ones most affected by CoViD-19.
As per the latest MPC statement, the Reserve Bank has announced liquidity augmenting measures of ₹9.42 lakh crore (4.6 per cent of GDP) over the last few months targeted towards liquidity infusions and revival of the Economy. As the economy heads towards revival, there would arise a need for a further boost. Thus, prudent measures in the present are essential, avoiding burning out to too much monetary space. The effect of the current measures will be fully realized only via adequate lending undertaken by the banks, which have remained extremely risk-averse, given the uncertainty. Growth in lending activates on account of rate cuts are likely to happen rapidly in a period of economic boom, making the current times challenging.
The way forward in terms of restoration of economic activity thus depends on multiple factors including the speed of containment of the pandemic, restoration of economic activity, smoothening of supply and revival of demand. The impact of combined fiscal-monetary stimulus and other administrative measures for revival for growth will also be crucial.
The article has been jointly authored by Shalini Pathak, Prarthana Verma and Akshita Gulati, Economic Analysts at Arthashastra Intelligence.
References
The Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework (2014)
Fifth Bi-monthly Monetary Policy Statement, 2019–20 Resolution of the Monetary Policy Committee (MPC) Reserve Bank of India (December 05, 2019 )
Sixth Bi-monthly Monetary Policy Statement, 2019–20 Resolution of the Monetary Policy Committee (MPC) Reserve Bank of India (February 06, 2020)
Seventh Bi-monthly Monetary Policy Statement, 2019–20 Resolution of the Monetary Policy Committee (MPC) Reserve Bank of India (March 27, 2020)
Monetary Policy Statement, 2020–21: Resolution of the Monetary Policy Committee (MPC) May 20 to 22, 2020
Statement on Developmental and Regulatory Policies, May 22, 2020
Minutes of the Monetary Policy Committee Meeting May 20 to 22, 2020 [Under Section 45ZL of the Reserve Bank of India Act, 1934]
RBI Governor’s Address, 22 May 2020
RBI Governor’s Address, 17 April 2020
[1] Data Source: DBIE, RBI
