Monetary policy to pump growth
RBI’s data-backed forward view should be able to reinforce confidence in entrepreneurs to stimulate economic activities
The Reserve Bank of India (RBI) in its recent monetary policy review has kept the repo rate (rate at which it lends money to commercial banks) intact at 4% and reverse repo rate (rate at which it borrows money from commercial banks) at 4%. But it has done a good service by providing optimistic forward guidance with convincing data that: inflation at 6.69% in August 2020 — oscillating beyond the RBI comfort level — will begin to recede in Q4 of FY21 and can go down to 4.3% by Q1 of 2021-22 as the supply side dynamics improve with the opening up of the economy. GDP will improve from minus 23.9% recorded in Q1 of 2020-21 and is poised to enter positive trajectory by Q4 to end the current fiscal at -9.5% while its downside risks cannot be ruled out due to the pandemic.
Instead of using rate cut as a market signal, the RBI used its market intelligence and external expertise to carve out innovative enablers and infused convincing optimism. Reinforcing its commitment to maintain an accommodative stance of monetary policy as long as it is necessary to revive growth, throughout this fiscal and into FY22, is a clear sign that the option of a rate cut in coming times is not closed.
More than such affirmation, the data-backed forward view should be able to reinforce confidence in entrepreneurs to stimulate economic activities. Building upon the pulse of early signs of recovery, the RBI could well balance between priorities of growth and inflation.
Pace of Recovery
Comparing early high-frequency growth indicators, the RBI provided data of pre-covid level of February and August 2020. It identified agriculture and rural sectors as key stimulators to prop up growth impulses. Rise in sales of tractors, two-wheelers, three-wheelers, spurt in agriculture exports and sale of fertilizers have demonstrated an impending sign of recovery. The eight core industries (ECI) index improved from 60 in April 2020 to 85 by August.
Increase in production of steel, cement and electricity is notable. Production of automobiles recorded higher sales. Construction, transport and domestic trade also reflected buoyancy. The composite Purchasing Managers’ Index (PMI), which dropped from 57.6 in February 2020 to 7.2 in April 2020, has bounced back to 54.6 in August cruising fast towards the pre-Covid levels. These affirm the optimism of the RBI and provide a sense of confidence to markets.
Credit Push
The bank credit growth trailing at 5.26% year on year on September 11, 2020, against a deposit growth of 11.98% needs immediate attention. Considering the constraints of banks in lending, the RBI increased regulatory limits for the retail portfolio. The maximum aggregate retail exposure limit of banks to a single counterparty increased from Rs 5 crore to Rs 7.5 crore. It rationalised differential risk weights on individual home loans and linked it to only loan to value ratio (LTV) sanctioned up to 31 March 2022. It can create demand for high value loans of over Rs 75 lakh. The proposed reduction in risk weights is expected to save close to Rs 500 crore of capital of banks.
The scheme of ‘co-lending model’ for banks and nonbanks, introduced in 2018, has now been extended to all non-banking financial companies (NBFCs), including housing finance companies. It will enable financial intermediaries to leverage comparative advantage. With these innovative enablers, banks should rework on speeding up credit delivery to reach out to ailing sectors, more importantly, to bank-dependent entrepreneurs at the bottom of the pyramid.
Liquidity Support
Right from the outbreak of Covid, the RBI has been supportive in pumping liquidity close to Rs 10 lakh crore so far in different forms. Continuing its policy to extend sufficient liquidity support for the stability of financial markets, it is actively working towards ensuring softer yield curves to rein in the cost of government borrowings. While doubling the size of each auction to buy bonds to Rs 20,000 crore, the RBI for the first time included state development loans under open market operations . Earlier, it increased the investment limit of banks in bonds to be classified as held to maturity (HTM) from 19.5% to 22% of net demand and time liabilities (NDTL) that was slated to end in March 2021.
To enable banks to plan their investment strategy in Covid times, the RBI extended such facility to March 2022 for securities acquired between September 1, 2020, and March 31, 2021. The portfolio in HTM also does not carry market risk that provides comfort to banks in managing liquidity. The RBI has also proposed to conduct on-tap targeted long term repo operations (TLTRO) with tenors of up to three years for a total amount of up to Rs 1 lakh crore at a floating rate linked to the policy repo rate that assures medium term and long term liquidity to banks. RBI is open to increasing the amount and tenure of TLTROs depending upon the response and liquidity needs.
Another notable regulatory change is to allow domestic high value remittances through Real Time Gross Settlement to operate round the clock and the year. The National Electronic Funds Transfer (NEFT) system is already working uninterrupted. These domestic remittance facilities should be able to expand the scope for greater use of digital mode to remit funds and can increase buoyancy in settlement of financial transactions.
Taking Forward
Amid the convincing growth optimism transcending the economy, the RBI has created reinforcing support structures with ample liquidity, credit growth enablers and above all the assurance to stand with industry for necessary interventions to ensure that the economy recovers faster and catches up with pre-covid status soon.
Using the synergy of the sops provided by the RBI, the stakeholders have to work in implementing them to achieve the desired growth objectives. Banks and nonbanks have to get into aggressive mode to work together and pump prime credit flow to the needy entrepreneurs. The pace of recovery can be accelerated only if the implementation is in sync with the letter and spirit of monetary policy dispensation.
(The author is Adjunct Professor, Institute of Insurance and Risk Management, Hyderabad)
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