When we see the latest monetary policy of the RBI, it needs to be appreciated in the light of the problems facing the economy due to somber growth prospects of the global economy as well as the impact of the Covid shock. The central banking is facing an unprecedented challenge globally and it is at crossroads. The outbreak of the Covid-19 pandemic has derailed most of the economies in the world including the developed ones. This has thrown challenges on both fiscal and monetary fronts.
Challenges on the fiscal front
On fiscal front the most proximate problem is how to provide social security to the people who are facing unemployment due to retrenchment or closure of their firms and enterprises and fiscal incentives to the businesses which had to stop economic activities due to lockdowns in order to contain the spread of Covid-19. The governments have announced social security initiatives including food security as well as stimulus packages to resuscitate the economic activities. This has put immense pressure on the national budgets while governments’ revenue collection has plummeted to unprecedented lows on account of long break in manufacturing activities and various economic services including trade, tourism, transport, hotels, construction, education and entertainment etc.
Challenges on the monetary front
On the monetary front the challenges are manifested in ineffectiveness of lowering interest rate and increased liquidity in investment and capital formation. Credit is available but there are few takers. People are averse to buy durables due to uncertainty in their income flow at the time of Covid pandemic while entrepreneurs are risk averse. Although the primary goal of monetary policy is inflation targeting and maintaining that target, the expectations from monetary policy is not limited to this. In fact traditionally monetary policy is supposed to give a push to economic growth along with maintaining price stability. The “twin balance sheet problem” being witnessed in India wherein the corporate sector is risk averse to invest and banks are cautious in lending due to build up of huge Non-performing assets has thrown an insurmountable crisis before the bankers as well as the policy makers.
Expectations play a very important role in maintaining economic growth and price stability. The global business environment is facing unprecedented problems due to the US-China trade war, climatic change and natural disasters, especially the outbreak of the Covid- 19 pandemic. Expectations of growth and price stability have suffered a jolt. Production and manufacturing has been disrupted for quite some time while unemployment is on the rise and stays at all time high. Supply chains have been broken around the world at domestic economies as well as the world economy. Aggregate demand at the time of unemployment and wage cuts witnessed throughout the world, is facing downward pressure. The virtuous cycle of growth has been broken and all the economies of the world are facing negative expectation and uncertainties as seen in risk aversion both at the consumers and investors levels. To buoy the economy in these difficult times it needs to repair and mend the economic expectations so as to reboot the economies and act in sync with the “new normal”. A new normal that is suitable to overcome the constraints which have unfolded and still keep on unfolding in this Covid affected time and at a time when there is widespread disenchantment with the liberal economic thinking and policies.
Where do we need to act?
However, growth is the primary responsibility of economic policy and fiscal policy. It becomes amply clear from the remark of a central banker, Lesetja Kganyago, South African Reserve Bank governor, who remarked “…most of our growth problems should be addressed through structural reforms and confidence-boosting measures… the central bank cannot stop electricity load-shedding with interest rates.” The issues of growth cannot be solely addressed by monetary and fiscal policy but structural reforms and building a positive expectation are equally important. When governments are having political interests in precedence in their agenda over economic issues, it is very unlikely that structural reforms and making a positive business environment is possible with the pace that these things deserve.
What India is doing?
India’s case is in sight. In recent times RBI in its monetary policies has slashed rates severely, poured inordinate liquidity into the system and indulged in extraordinary regulatory forbearance. Yet, the economy has barely responded. India’s growth rate was declining even before the Covid-19 shock. The reasons may be many and varied, but it was visible that the savings and investment rates along with capital formation were declining for months altogether even before the Covid outbreak. The problem of entrepreneurs, especially those in the MSMES, faced the brunt of sudden and abrupt demonitisation move of the government on one hand and now facing the initial teething pangs of the GST on the other, with unpredictable consequences. Market expectations are low and government incentives are proving inadequate.
RBI August 2020 Monetary Policy
- RBI Governor Shaktikanta Das announced (August 06) that the repo rate will remain unchanged. The RBI MPC has unanimously voted to maintain the status quo on policy rates.
- The MPC will remain watchful with respect to inflation dynamics to further use space available on the monetary side when appropriate.
- The RBI Governor also announced stimulus measures, which included additional liquidity of Rs 10,000 crore at repo rate to NABARD and NHB.
- Among other measures, the RBI allowed stressed MSME borrowers to restructure debt if their loans were classified as ‘standard’ as on 1 March 2020. The MSME loan restructuring scheme was already in place, but, due to the coronavirus, the MSME pain has been aggravated, and this warrants additional support.
- In an effort to mitigate the impact of COVID-19 on households, the RBI has increased the permissible loan to value ratio (LTV) for loans sanctioned against pledge of gold ornaments and jewellery for non-agricultural purposes from 75 per cent to 90 per cent till 31 March 2021.
Keeping key policy rates unchanged
The Reserve Bank of India, in its latest (August 2020) monetary policy meet decided to keep the key policy rates unchanged after two emergency rate cuts amid the COVID-19 disruptions and its ensuing economic fallout. Consequently, the repo rate stands unchanged at 4% and the reverse repo rate at 3.35%.
Latest Policy rates
|CRR Rate||SLR Rate||Repo Rate||Reverse Repo Rate|
Maintaining an accommodative stance
Though the economy is still far from a significant revival and needed monetary policy support, inflation took center stage. Retail inflation, measured by CPI, rose to 6.1% YoY in June from 5.9% YoY in March, breaching RBI’s medium-term target of 2-6%. The Montary Policy Committee (MPC) maintained accomodative stance.
RBI noted that the economic activity had started to recover from the lows of April-May. However, the recovery momentum is petering out due to the new trend of rising COVID-19 infections.
RBI on economic outlook
Regarding the RBI’s outlook for the economy, the MPC has assessed that the headline inflation will remain elevated in the second quarter of FY2020-21. It expects inflation to moderate in the second half of FY2020-21, though uncertainty remains. In terms of growth projections, the committee expects real GDP growth to be negative in FY2020-21. The MPC did not provide any forecasts for inflation and growth.
Analysts agree that keeping the key policy rate unchanged seems prudent, given the uncertainty on the inflation front and the fact that the RBI has provided significant accommodation in the recent months. Two emergency rate cuts of 115 bps before have not helped considerably to encourage borrowers to borrow more. The non-food bank credit growth at 6.7% in June 2020, is still lowest in around three years. Since at this stage, the level of economic activity is largely constrained by the spread of COVID-19 infections, another rate cut wouldn’t have helped in reviving economic activity substantially.
RBI’s monetary policy has emerged as a critical policy tool for achieving overall macroeconomic management, price stability, and growth. The conduct of monetary policy has evolved over time on the front of the policy framework and operating procedure. Back in the 1980s, when the economy was plagued by high inflation fuelled by excessive money supply in the form of RBI credit to government, price stability became utmost important. So, RBI adopted “monetary targeting with feedback” (targeting money supply) as the monetary policy framework suggested by the Chakravarty Committee (1985).
With the development of the financial sector, liberalization of the economy (1991) and freeing up of interest rates and exchange rates, RBI shifted its focus from exclusive reliance on monetary aggregates to a broad set of indicators. Therefore, in 1998-99 RBI started pursuing the multiple indicators approach only to later face problems associated with fulfilling multiple objectives.
However, on the recommendations of the Urjit Patel Committee (2014), RBI shifted to a new monetary policy framework of “inflation targeting”. Since 2014-15, RBI has kept its mandate of achieving price stability and growth via inflation targeting.
Need for acting together
There has been conflict between the fiscal and monetary policies at times. It needs to be appreciated that monetary policy should factor in the present ground realities in framing its responses. Inflation targeting is what the Central bank is responsible for, but its monetary stances have remarkable bearing on economic growth as well. For the RBI to achieve its inflation target it is very important that fiscal policy also moves in its support, i.e., maintaining the fiscal deficit under control. Similarly it is also important that the central bank keeps its interest rates and credit policy in chime with the growth targets of the government. To achieve this goal, a national Monetary Policy Committee has been in place for quite some time and the role of this committee assumes more important in these difficult times to work together to optimise the goals of growth as well as price stability.