RBI’s response to the Pandemic: Part 1
The current times are tough, really tough!
The World has come to a stand-still, a situation it has never faced before. Every discussion platform ranging right from the epitome of the hallowed halls of the United Nations to the rugged comment sections in social media are abuzz with one word -“Coronavirus”. The fact that a bunch of tiny little creatures, well can’t even call them creatures, invisible in front of the naked eye, have turned the world upside down. This is highly intriguing and thought-provoking from a philosophical perspective but today this is not our topic of interest. You see, all of our news feed these days is filled majorly with articles elucidating the impacts of the virus in terms of the number of lives lost or affected. Unless you are a finance guy!, seldom you will pay attention to something like “RBI introduces new measures to, to fight the economic slowdown”. Even if you do, it becomes really difficult to grasp what’s going around with all those heavyweight giants of the financial vocabulary standing in your way with all their pride and glory. This blog is just a highly simplified version explaining all those measures taken up by the RBI to prevent the largest democracy of the World from falling into an economic recession.
Some Stats!
Well, in this sense, this blog won’t exactly do justice to the noble work being done by those economic gurus sitting at the apex of the Indian Financial System. So. before proceeding let’s just look at some stats which depict that the current global recession is actually the greatest of all times and so far, India has been doing a fantastic job and, good news! it is expected to do the same as well :)
Here’s a short story to put light on the severity of the issue: “Germany’s 30-year bond yield fell below -0.2% for the first time on Thursday to a low of -0.232%, while 10-year German bonds were 2.5 basis points lower at -0.674%”-read a piece of the news report. If this bond yield thing sounds alien to you, here’s the thing: suppose a government requires funds, it will need loans. Bonds are similar to loans where the government says hey you give me some X amount of money and I will return this in the form of timely interest payments and the principle in the end. The return which this investment will yield to you as an investor is the “yield of the bond”. You are parking your hard-earned money with the government, in return, you will ask for more money, right?! This happens when times are normal when the economic outlook is positive when you expect your money to grow but these times are anything but normal. So that cheeky little headline up there says that people are giving loans to the government, the German government, yes one of those most advanced and developed economies of our time, and this loan doesn’t yield them anything instead of in return they will get less money and people are happy to do this as this is the best investment option they have!!! (Please note that in the case of Germany this negative yield was not only due to the current pandemic but it certainly worsened the situation) Now, this was an overly simplified explanation but this pretty much sums up that the times are terrible!!!
“As a result of the pandemic, the global economy is projected to contract sharply by 3 percent in 2020, much worse than during the 2008–09 financial crisis”, this was the statement released by the International Monetary Fund (IMF) on 14th April 2020. A contraction of -3%, dude this is what we call recession! A goddamn negative growth rate! Now on the brighter side: “the IMF on Tuesday projected real GDP growth of 1.9 percent for India in 2020, as the global economy hits the worst recession since the Great Depression in the 1930s.” read a report in the Economic Times. They are reporting a “positive growth” for India during the worst recession since the Great Depression of the 1930s (If you haven’t heard of the Great Depression of the 1930s, time to pull out your history books!). During a time when the whole World is whirling into a recession, at a time when questions of a negative economic outlook were already looming large on the central government, how is India managing to fare so well?! Also, why are global economic bodies expecting us to do so well!!
You see when all the limelight in the news is being captured by those naughty little coronaviruses, a hero was fighting constantly at the war front against the woes of the current recession to keep our financial system in place. Had it not been for the unconventional measures taken up by our own RBI, our system would have collapsed! Commercial Banks would have stopped giving loans, enterprises might have stopped producing goods by now due to lack of funds, the unemployment rate might have skyrocketed by now due to mass firings, the wealthy businessman in your locality might have gone bankrupt and………booom! Let’s not go further into this :(
Let’s try to understand how RBI is trying to tackle the current situation and what are the challenges!
The Main Story
It’s been a time since I started blabbering about RBI’s achievements in keeping the financial system in place. Well, what if you ask why we need the financial system? Let’s delve into the basics!
Imagine yourself as a budding businessman and you plan to start a small scale enterprise about producing a good. You’ve researched well about the market and your product is going to fit well into the system, you’ve laid out all the plan related to marketing, advertisements and studied the supply chain which will land your product from the conveyor belt to the retail stores. So, you are on course to make some bucks…..yeah!!!!! But wait, there is one thing which is missing. You are not among those top1% billionaires of this country and you need initial funding to start your operations. Where do you get this from? Now you go to a lending organization say a bank ( or an NBFC — Non-Banking Financial Corporation, we will get into these later! ) to ask for a loan. They give you a loan, you start your operations, you make money, your consumers are happy, you provided employment to people to run your operations smoothly and then you pay off your debt. Now, you are self-sufficient, after all, you made these heavy bucks, you are looking for expansion. Slowly, you expand your business and various other ambitious folks like you follow the same path. They bring in some other products, they start their own business, they make a lot of profit, they create employment for a lot of other people…..peace, happiness, and development all around…cheers. Your hard work and sincerity have paid off and you have brought in prosperity for your beloved country, hats off to you man! But, if you wait and reflect for a while, the real oil which keeps our economic engine running is the little role the bank played in this story….funding!!! This pretty much sums up the need for a financial system. Ensuring a smooth flow of capital across the country to connect the people who need money with those who want to turn their savings into investments is pretty much all our financial system does. Well, this may sound very simple and easy but it is really a daunting task given the number of factors that come into play. We won’t jump into studying how the financial system work as this isn’t what I promised in the beginning. So let’s jump into challenges the system is facing and how RBI is trying to curb the same!
The pandemic has stopped the revenue flows for companies. People can’t go out and work, make purchases, or do anything. The economy which stands on the pillars of output and consumption has thus faced a huge blow. Medium and small scale enterprises are suffering the most severe blows. Imagine what happens to the banks and other lending agencies who had lent their money to these firms. They can’t get their repayments back. Transportation, Education, and Tourism sectors are the worst hit. They still have costs but no revenue to cover those. These companies are in dire need of funding to keep themselves alive. This is what we call Liquidity Crunch. A situation of this sort already existed in India due to the famous NBFC crisis of 2018. RBI was already introducing measures to fight against those that now we have a bigger problem. So, broadly we can say that the current economic crisis in India can be resolved to a large extent if the liquidity needs of companies are resolved. This isn’t a simple task. RBI doesn’t directly lend to private enterprises. It lends to banks which then lend out money to other lending agencies and their clients. Suppose you are a large bank, a real estate tycoon comes knocking at your door asking for a loan to keep his latest project alive. You are living in a pandemic where people aren’t even allowed to move out, purchasing a house is unimaginable. Hence, huge uncertainties are revolving around the repayment of the loan. Will you give him a loan? This is not the case with one single business. Most of the businesses across the nation are facing these issues and all lending agencies are unwilling to grant loans for reasons which are obvious now!
Just when everything starts to seem gloomy and you feel the end of the World is here, up steps the Reserve Bank of India to save the day! RBI is working majorly on resolving two issues: Liquidity and Credit Flow. Smooth credit flow ensures that “Help is always be given at Hogwarts to those who ask for it”. Replace Hogwarts with India, Help with credit (or loan), and Albus Dumbledore with our own RBI. Suppose RBI resolves the liquidity issues and now the banks are ready to lend money to the ones in need. It will be very easy for large enterprises to avail loans as they have a higher chance of post-Covid recovery as compared to a small scale enterprise. But RBI needs to ensure that “credit keeps flowing in all sections of the system”. The technical details of RBI’s approach is a story for another day as we have already come a long way!!
The next time an article related to the economic impacts of the pandemic pops up in your news feed, I hope you aren’t as puzzled as you were before. In a later issue, I will try to cover the technical details of the measures introduced by the Reserve Bank. Until then, stay safe everyone!
