Covid-19 Response: This RBI Is Different!
There will be a difference between the shape of the post-epidemic recovery in manufacturing & services, writes Soumya Kanti Ghosh.
After the global financial crisis, central banks like the U.S. Federal Reserve and the European Central Bank have been constantly interacting with the financial markets and have taken a plethora of unconventional measures to stabilise the market architecture. The Reserve Bank of India, under the current dispensation, can now be equally counted in such an august league. In fact, taking recourse to “constrained discretion” in policymaking as the RBI is currently doing is an essential attribute of modern-day central banking. This RBI needs to be sincerely complimented for that.
The 2008 financial crisis was a global economic catastrophe. It sparked the Euro crisis, from which countries recovered slowly, with many experiencing a lost decade. Some fear that the Covid-19 pandemic will be just as bad. There is a big difference between the uncertainty we faced then and now. The scale and the severity of the financial crisis were difficult to predict in both the short and long run as it was unfolding. However, the coronavirus pandemic is more predictable, at least in the long run, but not in the short run, when the impact could be devastating. In effect, the impact is actually time-inverted. The long-term effects on the economy will be less severe than the financial crisis, as long as governments and regulators act quickly to contain the economic fallout, and this is exactly what the RBI has done on Friday after the government announced the first set of measures.
There is one caveat, that the impact on India will be large and hence the need for a policy bazooka. Once the epidemic is over, there will be some catch-up in growth as businesses restock inventories and consumers make up for forgone spending.
There will be a difference between the shape of the post-epidemic recovery in manufacturing, which will probably experience a sharp rebound, and the services sector, which may struggle for a longer period as consumers will not be able to make up for ‘social consumption’ – such as meals out, concerts or travel – that has been foregone now.
Hence the need for forbearance as the RBI has to give support to such businesses as it will also give the confidence to bankers to extend loans, long after the pandemic has ended.
Three-Pronged Response
The RBI monetary policy response to this severe—yet temporary—shock should have three key elements, and these are exactly what was unleashed by the RBI.
First, safeguarding liquidity conditions in the banking system through a series of favourably-priced traditionally liquidity measures, including aggressive policy rate and cash reserve ratio cuts.
The repo rate has been cut by 75 basis points, the corridor has been widened and CRR has been cut by 100 basis points along with adjusting daily CRR requirements.
As the retails loans have been linked with the repo rate since Oct. 1, 2019, the reduction in repo rate will facilitate immediate transmission as rates are reset at the beginning of every quarter. The 1 percent cut in CRR from 4 percent to 3 percent for one year ending March 26, 2021, will infuse liquidity to the tune of Rs 1.37 lakh crore and also help in reducing the cost of funds for banks. In addition, the reduction in daily CRR maintenance requirement to 80 percent from 90 percent currently till June 26, 2020, will provide some relief for banks’ reporting requirements for its treasury staff under the current exceptional circumstances.
The increase in Marginal Standing Facility limit to 3 percent from 2 percent, applicable up to June 30, 2020, will provide additional liquidity of Rs 1.37 lakh crore under the Liquidity Adjustment Facility. Such a move will also help banks in computation of SLR.
Second, protecting the continued flow of credit to the real economy through a fundamental recalibration of the targeted longer-term refinancing operations and a universal forbearance programme for stressed sectors to bank credit flows to such sectors after the crisis is over.
The RBI has introduced targeted long-term repos (of up to three years tenor) with the explicit condition that it to be deployed in investment-grade corporate bonds etc. will help in reducing the spreads over government bonds. The LTRO would facilitate banks over time as the quantum magnifies to undertake maturity transformation smoothly and seamlessly, so as to augment credit flows to productive sectors as LTRO is durable liquidity and will substitute frictional liquidity in the banking system.
Also, LTRO has no negative carry on the cost of funds because of no CRR requirement.
Moreover, such investments will be included in the held-to-maturity portfolio. Currently, excess SLR of all scheduled commercial banks stands at 8.35 percent or Rs 11.91 lakh crore. So the banks which are holding excess SLR available can invest them in these avenues. Investments made under this facility will be also exempt from Large Exposure Framework limits.
To give relief to borrowers amid the ongoing coronavirus lockdown, RBI has allowed a three-month moratorium for all term loans. For new loans, each bank’s internal policy may differ, keeping borrowers’ repayment capacity into account. This will provide stability and ease the stress on individuals and organisations.
We believe that such a deferment could be sizeable and close to Rs 4 lakh crore. This will also help banks to not face additional provisioning norms.
Third, via an aggressive increase in the asset purchase programme, and adjustments to the capital conservation buffer, a countercyclical buffer, and buffers for systemically important banks that will prevent financial conditions for the economy to tighten in a pro-cyclical manner.
The deferment of the implementation of the last tranche of 0.625 percent of capital conservation can have capital ease of around Rs 60,000 crore, which will be very crucial for banks and can be converted to a business opportunity of more than Rs 8 lakh crore.
In these testing times, please take care of yourself, and your family!
Soumya Kanti Ghosh is Group Chief Economic Advisor, State Bank of India. Views are personal.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.
