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Observations of EGROW Shadow MPC on RBI's Monetary Policy on May 21, 2020


A. Views of Members on the EGROW Shadow MPC

1. Dr. Arvind Virmani, Chairman EGROW Foundation

The greatest threat to the economy during lockdown is the asymmetric financial obligations created by it. Producers and sellers of goods and services are required to shut down under the disaster management act, while their legal obligations to pay rents & interest, repay debt, and for companies with more than 100 employees to keep employees on payroll and pay full wages. Some Governments have added to this asymmetry by ordering SMEs with less than 100 workers, to pay full wages. This is a recipe for bankruptcy.

It is essential for RBI to remove the asymmetry with respect to interest payments and debt repayments and the Govt. should remove all other asymmetric legal obligations which are likely to push firms into bankruptcy. RBI's extension of moratoriums and conversion of accumulated interest into term loans are welcome steps in this direction.

RBI needs to focus on sectors which have been NPAs since the global financial crisis, those which bore the brunt of the 2019 growth slowdown and those which will continue to suffer from the Pandemic. These will need a comprehensive loan restructuring package, once the lockdown is phased out nationally. RBI and Govt should ready a comprehensive framework, which will also deal with the Public sector Banks aggravated NPA problem.

2. Prof. Ashima Goyal, IGIDR and Member, PMEAC

The MPC process has once again been preponed reflecting the challenges we face, but also reflecting better cooperation between monetary and fiscal policy now, where each seeks to make the other more effective. This is essential in these troubled times. The fiscal package announced in mid-May chose not to go overboard in expanding the fiscal deficit and government borrowing, instead taking on the credit risk in order to induce banks to give more loans thus using the large liquidity created by RBI.

Just as the government package will help turn liquidity into loans, the 40bps interest rate cut and other easing of financial conditions will reduce the cost of loans. The RBI has also clearly mentioned in the regulatory and development statement it stands ready to support state and centre borrowing. Excessive deficits would have made it difficult to do so without a risky over-expansion in money supply.

Noteworthy in the statement is information on how rates cuts combined with surplus durable liquidity have led to interest spreads coming down substantially through the entire spectrum of interest rates—transmission is working. Many high frequency indicators show this combination had led to an upturn in February-March in the real economy also, before covid-19 struck. Now that reverse repo rates have fallen even more and credit risk reduced for them, banks have even greater incentives to expand lending. We should see an expansion in lending as activity revives.

3. Indranil Sengupta, Chief Economist, Bank of America Merrill Lynch

We welcome the RBI MPC's decision to cut 40bp in the preponed meeting on Friday. Our base case sees real GDP contracting by 1.3% in FY21 assuming the lockdown ends by end-June and re start till mid-August. It can fall by 5% if we have to remain in semi lockdown till a vaccine is found. We expect inflation to ease to 2.5% in 2HFY21 on base effects, good rains and weak demand.

Looking ahead, we expect the RBI MPC to cut by 50bp by October. The RBI will have to buy Gsecs of US$75bn through OMO/private placements.

4. Ms. Upasna Bhardwaj, Chief Economist, Kotak Mahindra Bank

RBI’s round-three measures focuses on smoothening the functioning of the financial markets and easing the market risks brewing in the economy. While the policy meeting got preponed unexpectedly by a fortnight, most of the measures announced were broadly in line with expectations, with no specific surprise bazooka. Notably, given the uncertainties RBI gave directional view on the growth-inflation trajectory while refraining from providing any specific forecasts. RBI realistically acknowledged that growth is expected to contract in FY21, while inflation is expected to remain elevated in the near term amidst supply side disruption. However, in 2H RBI expects inflation to trend lower than 4% thereby providing room for further easing.

While, the supply and demand side disruptions definitely makes the forward looking inflation trajectory uncertain, growth is clearly expected to remain in negative zone. We expect Real GDP growth at (-) 5.8% in FY21, with likely stability visible not before the end of 3QFY21. In that backdrop, we see room for further easing by 25-35bps. However, any additional easing beyond that may become difficult given the limited space available with the money market rates already trading far below the reverse repo rate. The average overnight rates have been trading ~75bps below reverse repo rate over the last month when RBI announced the widening of the policy corridor. After the recent 40bps rate cut, we could see effective weighted average overnight rates closer to 2.5-2.6% clearly limiting any aggressive policy easing going ahead. Any case, lowering rates is not incrementally expected to provide any meaningful impact on the issues plaguing the financial and real economy.

With the third round of measures done, we now expect a clear communication by the RBI on aggressive OMO purchases to support the bond markets. The Central Bank can also allow for HTM provisions for G-Sec and SDLs issued in 1HFY21, given the heavy supply pressure building in the market. Eventually under extreme stress, the central bank will need to explore direct monetization of government deficit but that decision could be back loaded. Special deposit facility could be introduced for prudent liquidity management and deployment—although such a move would only benefit the shorter end of the yield curve. Additionally, one-time loan restructuring for distressed assets should be explored. The government under the Special Liquidity Scheme, may look to tweak the tenure of the scheme for NBFCs/HFCs beyond 3 months and probably can consider expanding it for distressed corporates as well. RBI in response to the COVID-19 crisis has been fairly proactive and I expect greater focus on regulatory tweaks and addressing credit risks which will be more effective in this environment rather pushing Repo rate aggressively lower. I recommend 25-35bps of rate cuts followed by a pause.

5. Dr. Charan Singh, CEO and Director, EGROW Foundation

The RBI’s readiness to address the issues in the economy are apparent with the advancement of the announcement of Monetary Policy by nearly a fortnight, keeping in mind the uncertainty and unfolding of the dynamic situation because of the prevalent pandemic. This is a welcome step.

The direction of the policy is also very clear as reflected in the reduction in the Repo Rate by 40 bp and extending of the moratorium by another quarter. My understanding is that the RBI is preparing for a long haul, given the empirical evidence of 1918 pandemic which came in waves, and where the second wave was far more lethal than the first wave. Then, the time period of waves spanned for nearly 18 months. Thus, the monetary policy has to be prepared accordingly.

The Policy announcement mentions that growth rate in FY21 is expected in the negative zone. This is a cause of concern to which I think some reconsideration is required. In the lockdown, activities with a weight of about 40 percent in GDP, mainly essential activities, have been continued. Similarly, Rabi crop has had a good harvest, and with Southwest Monsoon predicted to be good, Kharif crop is also expected to be good. In addition, schools, colleges and other educational institutions have shifted to online classes, and IT industry has permitted employees to work from home during the lockdown. Finally, only 2 months of lockdown, and that during the lean period of hot summer and monsoon, implies that economy has chance to recover in the next 10 months, of which 6 months are of the traditional busy season, when economic activities generally boom in the country. On opening of the lockdown, Govt could consider permitting longer hours of working per week. Some sectors, mainly in services, like travel, tourism and hotel could be impacted. But the initial signs are positive when aviation is opening and hotels are finding alternatives to conducting operations. Restaurants are already shifting to take-away joints. Thus, the projection of growth in the negative zone may need a revisit.

The global economy is also passing through a difficult phase and the impact is unprecedented, as the whole world, advanced, emerging and low income countries are simultaneously closed down. Seeking foreign support is not an easy task when all other countries are passing through the same process of fiscal stress and monetary policy is loose and accommodative. The prospects of exports are bleak for India, under such circumstances.

Therefore, India has to look inwards, in its villages and Tier - II and Tier – III cities for demand and opportunities in reviving the economy. To finance such revival, there would be need for close coordination between the fiscal and monetary authority. Illustratively, with return of migrant labor, can opportunities in the local area be created and village economy strengthened. The handloom sector, in contrast to power sector, can be encouraged as also village and cottage industry. At low cost of capital financing, some engagement and employment opportunities can be created in the local areas, mainly in villages and small towns. NABARD, SIDBI, and cooperative banks, urban and rural, can play an important role here, especially when Adhar seeding has been done for most bank accounts and national ration card is being introduced, whereby individuals are under active KYC. The Government was discussing about smart cities recently and now, with COVID, discussion is about positioning India as an alternative destination to China. The two can be combined and location of smart cities identified. The lack of opportunity for commercial banks in extending loans reflected in excess liquidity with commercial banks, placed daily under Reverse repo, can be used to finance/establish Smart cities which can be guaranteed by the Central and State Governments. The creation of smart cities will generate employment too and engage local labor and returned migrant labor. To encourage banks to scoot and scout for projects, can the Reverse Repo rate be reduced further, rather steeply. Even, the Repo Rate, following global trends, can be reduced further, as inflation, in this sluggish growth phase, cannot be a threat to business decisions and the economy. The usual argument to keep the interest rates high which is to protect the interest rate earnings of the pensioners on their deposits, can be addressed by keeping subvention rate high, and those accounts of pensioners ring-fenced and protected. Illustratively, even in normal times, senior citizens do get an additional benefit on interest rates. The general level of interest rates can be lowered further to revive investment and growth.

To conclude, the RBI is actively analyzing the situation and appropriately responding to the needs of the industry but as always, much more needs to be done to sustain demand, and revive the economy. The most important aspect for all policy makers is ensure that labor, including migrant labor is productively engaged, so that society at large is safe, and businesses confident of security of their assets.

B. Views of Industry Expert/Economist

Dr. Manoranjan Sharma

The difficult conditions are starkly reflected in complete collapse of global economic activity post the COVID 19 new normal of ubiquitous lockdowns and social distancing. Accordingly, Central Banks globally have hit the ground running and have frequently tweaked their policy rates.

With disrupted supply chains and falling demand, private consumption, which accounts for 60 % of domestic demand, has been devastated with consumer durables production slipping by 33 % in March 2020. The combined impact of demand compression and supply disruption will severely depress economic activity in H1 of this fiscal.

In India, there are grave risks with a free fall in the GDP growth to the negative territory for the first time in 41 years with some pick up in H2. Both urban and rural segments have taken a severe drubbing. Things do not seem to be improving any time soon.

In a yet another off-cycle meeting, the MPC slashed the repo rate by 40 bps to 4 %. The RBI has also announced Rs 8.04 lakh crore worth of liquidity-boosting measures so far. This will reduce EMIs on home, automobile, personal loans and term loans, boost market sentiment and consumer spend. But banks will lower the deposit rates to maintain their asset-liability balance with lesser returns to depositors and pensioners.

The Group Exposure Limit of banks has been hiked to 30 % from 25 % (from 25 % in June 2019) for enabling the corporates to meet their funding requirements from banks.

The RBI also announced help to SIDBI through refinance by rollover of a three month, Rs 15,000-crore facility announced earlier to provide additional liquidity support to MSMEs.

The RBI announced a Rs 15,000-crore line of credit to the EXIM Bank to help the sagging foreign trade.

Time for completion of remittances against normal imports was extended from 6 to 12 months from the date of shipment for imports made on or before July 31, 2020 to provide greater flexibility to importers.

For the financial markets, the RBI granted an additional three months to fulfil this requirement.

These measures will help in injecting liquidity in the market and disincentivizing banks from parking deposits with the RBI (Rs 8 lakh crore at 3.75 %). In the last few years, the banks have been severely hit by the double whammy of slow business growth and mounting NPAs. The fear of the dreaded 4 Cs- CVC, CBI, Courts and CIC, has made banks increasingly risk-averse. This steep reduction together with the clear downward bias of the interest rate would nudge the banks to advance greater lending to the productive sectors of the economy.

The MPC took the right call to revive growth and mitigate the pandemic’s adverse impact while checking inflation. But questions have been raised about the timeliness, adequacy and cost of credit, the effectiveness of Repo rate cuts, and the role of the fiscal policy in the resuscitation process. While in the medium term, both the monetary and fiscal policy must move in tandem, the fiscal policy has to play a more active role.