by Lekha Chakraborty and Harikrishnan S

As the Reserve Bank of India Governor Shri Shaktikanta Das puts it upfront, these are extraordinary times, and we need to respond with “whatever it takes” to deal with the pandemic. Over the past few days, our hope for systematically “flattening the curve” by containing the COVID-19 pandemic and moving to a quick V-shaped or U-shaped recovery is waning[i]. Evidence is increasingly pointing towards the situation worsening to a dual crisis — a public health crisis and a macroeconomic crisis — like never before.

The IMF projections substantiate that the drag of the pandemic on global growth could be to the extent of -3%. This is a major revision in the global growth rate over a very short period of time. The IMF highlighted that “the Great Lockdown is the worst economic disruption since Great Depression, and far worse than the global financial crisis,” and its estimates suggest that “the cumulative loss to global GDP over 2020 and 2021 from the effects of the COVID19 pandemic would be around $9 trillion, greater than the economies of Japan and Germany combined.”[ii] *(The IMF has since released its latest [June 2020] estimates, showing global growth declining 4.9 percent, for a cumulative, 2020-21 loss of $12 trillion.)

How have the central banks responded to this crisis?  This is evidently uncharted territory for the central banks — how to deal with “life versus livelihood” issues. The pandemic economics of central banks is twofold. One is the focus on measures that relate to instantaneous economic “firefighting”: for instance, how to ensure liquidity infusion into the system to stabilize the market reactions. The second is the long-term policy imperatives. As this crisis is of an unprecedented scale, it calls for unprecedented policy responses.

In India, the great lockdown was announced by the Prime Minister on March 25th, 2020. Subsequently, an economic package was announced in an iterative manner. To put things in perspective, in India, an agreement on a “new monetary framework” was signed between the Government of India and the RBI in February 2016, by which the single objective of our monetary policy is “price stability,” based on inflation-targeting rules. This policy transition from the discretion of the RBI governor to a rule-based monetary policy has constrained the central bank in its response to the economic growth slowdown and other economic uncertainties.  Yet another point to be considered is the central bank’s independence — “operational independence” — after the constitution of a Monetary Policy Committee (MPC) in India. The role of the RBI governor in taking crucial monetary policy decisions has been taken over by the MPC, based on their voting. As per Section 45ZL of the Reserve Bank of India Act, 1934, the RBI shall publish, on the fourteenth day after every meeting of the MPC, the minutes of the proceedings of the meeting which shall include the resolution adopted in the meeting, the vote of each MPC member, and the decisions regarding the policy rates, whether to increase, decrease, or maintain the status quo rates.

Let us unpack the COVID policy response by the RBI. On May 22, 2020, on the basis of an urgent offline meeting of the MPC — before their regular meeting — the RBI responded to the COVID pandemic by reducing the repo rate under the liquidity adjustment facility (LAF) by 40 basis points, to 4.0%, with immediate effect.[iii] This was a further reduction from the 4.40% announced in March 2020 (the repo rate is the rate at which banks borrow funds from the Reserve Bank against eligible collateral).

The reverse repo rate is the rate at which banks park their surplus funds with the RBI under the liquidity adjustment facility (LAF). The reverse repo rate under the LAF stands reduced to 3.35% from 3.75%. These rates were introduced in June 2000. Since then, the repo rate has remained the reference rate for signaling the monetary policy stance. The Cash Reserve Ratio (CRR) is cut by 100 bps. The Marginal Standing Facility (MSF) rate (overnight borrowing facility from the central bank for further liquidity) and the Bank Rate stand reduced to 4.25% from 4.65%. The MPC also decided to continue with the “accommodative stance” and their decisions are taken with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4%, within a band of +/- 2 %.

The RBI has responded to the COVID crisis by infusing liquidity into the system, to the tune of ₹5.66 lakh crore in May 2020 (up to May 20) from ₹4.75 lakh crore in April 2020. Within the liquidity package, 1,20,474 crore was injected through Open Market Operation (OMO) purchases and 87,891 crore through three Targeted Long-Term Repo Operation (TLTRO) auctions and one TLTRO 2.0 auction. In order to distribute liquidity more evenly across the yield curve, the Reserve Bank conducted one “operation twist” auction involving the simultaneous sale and purchase of government securities for 10,000 crore each on April 27, 2020.

In addition to infusing liquidity, the “regulatory easing” measures were announced to (i) promote credit flows to the retail sector and MSMEs and real estate developers; (ii) extend the regulatory benefits under the special liquidity facility for mutual funds (SLF-MF) scheme to all banks; (iii) extension of the loan moratorium and support for working capital financing till August; (iv) credit support to the exporters and importers; (v) extension of the tenure of the small business refinancing facilities; and (vi) increase the state’s Ways and Means Advance (WMA) by 60% (compared to 30% earlier) to monetize the deficit.

How effective these measures have been is anybody’s guess.  Even after bringing the rates (for borrowing) down to almost unprecedented levels, there was a huge increase in the funds parked by commercial banks in the RBI’s reverse repo account — which went up from ₹ 3 lakhs crores on March 27th to ₹8.4 lakhs crores by the end of April.  With unemployment rates going through the roof, needless to say, there has been a phenomenal crash in demand.  In such a scenario, focusing almost solely on liquidity measures serves only to plaster over the problem.

To conclude, how this crisis will permanently shift the economic structures depends on the epidemiology of the virus and the nature and severity of the economic shocks. In this uncertain environment, how countries emerge from the effects of the pandemic depends largely on the effectiveness of the policies they design now. Monetary policy needs to play a proactive stabilizing role in this scenario. However, the announcements so far were mainly targeted at reducing the policy rates and infusion of liquidity.  Pumping money into banks and NBFCs without adequate fiscal measures to boost demand runs the risk of increasing bad loans.  In fact, CRISIL has already predicted a rise of banking sector NPAs to 11.5% by March of next year.  As Joseph Stiglitz points out in his engaging analysis, “today’s excess liquidity may carry a high social cost. Beyond the usual fears about debt and inflation, there is also good reason to worry that the excess cash in banks will be funneled toward financial speculation.”[iv] And he warns that this could lead to a “climate of increased (economic) uncertainty” and end up “discouraging both consumption and the investment needed to drive the recovery.”  This could lead us into a “liquidity trap.”  Whether we are headed in this direction, only time will tell, but it does make one wonder whether, without demand being stimulated, these policies are enough to create a ripple.

(The authors are, respectively, professor, NIPFP, and an independent political analyst.)

[i] Harikrishnan S and Lekha Chakraborty (2020) “The Political Economy of Lockdown”, Multiplier Effect Blog, The Levy Economics Institute of Bard College, New York

[ii] Gopinath, Gita (2020), The IMF Presentation of World Economic Outlook, The IMF, Washington DC

[iii] Reserve Bank of India (2020), Monetary Policy Committee Minutes, RBI, Mumbai, May 22, 2020.

[iv] Stiglitz Joseph and Hamid Rashid (2020) “Which Economic Stimulus Works?”, Project Syndicate