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RBI is on right track but it can do a lot more

By Somnath Mukherjee

After several days, the Reserve Bank of India delivered big on monetary intervention in response to Covid-19. It wasn’t the nuclear option (some big weapons like monetization of fiscal deficit were not touched), but it certainly is a big Daisy Cutter (perhaps the largest non-nuclear, conventional bomb used in combat).

As a disaster policy construct, it is near perfect. It opens several liquidity taps – CRR (lowest ever level), MSF (expanded by 1%) – that significantly enhance the liquidity available to the banking system. It reduces policy rates significantly, and also skews the angle between the two (75 bps cut in Repo and 90 bps for Reverse-repo) to disincentivize lazy banking (of banks simply laying off extra deposits with RBI).

Together, enhanced liquidity and angular skew in the Repo corridor spread should also ensure better transmission of policy rates. The Targeted Long-Term Repo Operation (TLTRO) opens up the frozen corporate bond market and enables at least the highly-rated issuers (and mutual funds) access cheaper funding and liquidity. Forbearance guidance on bank loans prevents a wave of NPAs from swamping bank balance sheets. In a nutshell, RBI delivers on its main premise of maintaining the stability of the financial system.

It is important to realise though what RBI’s intervention is not about. It is not an economic booster with nearly enough ammunition to balance out the impact of an induced slowdown. No amount of incremental liquidity in the banking system can create new credit when enterprises are in lock-down mode. Even the most efficient transmission of policy rates will not goad the private corporate sector to undertake fresh capex when demand is uncertain and many (if not most) projects cannot be started due to the lockdown in place. Neither will (even well-off) consumers be able to spend on credit – not when automobile showrooms and malls are shut, and job/salary insecurities are rife. Add to it the negative wealth effect of a crashing stock market, which dampens sentiment even in the tiny topsegment of the consumer base. Above all, a large number of bottom-of-the-pyramid consumers, who will drastically cut back on consumption as livelihoods get disrupted. In a nutshell, no amount of easy money or low rates can induce consumption or investment during periods of extreme uncertainty.

It is too early, and the data (and outlook) are too uncertain to calculate the cost of the lockdowninduced slowdown with any level of accuracy. Estimates in the US range from a 10% to a 24% decline in GDP for the first quarter.

For India, estimates are somewhat more sanguine, but the predominant risks are all for further downward revisions. It is no surprise therefore that globally, governments have rolled out large fiscal plans. In comparison, the Indian fiscal intervention plan rolled out is lacking in scale. A safety-net programme with a headline outlay of 1.7 trillion has been rolled out. For starters, the headline is extremely modest in its scale – less than 1% of GDP. Further, closer scrutiny reveals that a lot of the headline outlay is upfronting of expenditure already budgeted for. The net incremental is an even more modest 40-50,000 crore. When entire swathes of the economy have been taken out of action, these quantums don’t move the dial nearly enough.

There are some suggestions that India cannot “afford” a large fiscal intervention as the fisc is already stretched and existing financial savings won’t be enough to fund large incremental government borrowings.

They miss the point by a mile and a half – empirically. US federal fiscal deficit is 50% higher than India’s (in % of GDP terms). Financial savings in several European economies (and in the US) are lower than India. In a crisis, a large fiscal outlay is merely a function of the society borrowing more from its future to fund its present. There are several windows of financing a much-expanded fisc in India.

To start with, demand from the private corporate sector on domestic savings is going to be invariably lower this year. The fiscal financing maths in India works out in the following broad-brush: 3-4% (of GDP) is the central fiscal deficit, another 3% is the state fiscal deficit – both adding up to 6-7% as demand from the savings pool. On the supply side, financial savings (households and private corporate) is in the 10-11% range – which leaves about 3-4% for consumer and corporate credit (bolstered by corporate sector access to foreign savings via ECB, FDI and FII). In a weak consumer (and corporate) demand scenario, a large chunk of the savings demand from them would be available for higher public borrowings.

Second, the crash in oil prices by $30/barrel are an immediate revenue soak – every $1 decline in oil is a $1-1.5 billion windfall. This would still leave $15-20 billion of incremental resources that the government can mop up.

Last but not least, there are the “nuclear” options of RBI buying out government debt directly. In colloquial terms, print money to buy government debt. Ordinarily, it’s a practice that is avoidable, but in extreme situations, merits outweigh the downsides.

The author is the managing partner at ASK Wealth Advisors. The views expressed in this article are personal.
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