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RBI Policy Amidst Covid-19: Decoding The ‘Whatever’ Of ‘Whatever It Takes’

Do rate cuts and periodic liquidity infusions constitute the “whatever it takes” stand? Will that be enough, asks Abheek Barua.

RBI Governor Shaktikanta Das, in Mumbai, on March 3, 2020. (Photographer: Kanishka Sonthali/Bloomberg)
RBI Governor Shaktikanta Das, in Mumbai, on March 3, 2020. (Photographer: Kanishka Sonthali/Bloomberg)

This time is truly different. The resolution of the Covid-19 crisis will “come from science”—as economist Steve Roach put it—and not efforts to repair the financial system that worked for other economic shocks: be it the Great Financial Crisis of 2008, the Asian Crisis of 1997, the Russian debt crisis of 1998, or 1987’s Black Monday. However, while science and healthcare will have to do the heavy-lifting in saving lives, the two strands of economic policy, fiscal and monetary will have to shoulder the burden of saving livelihoods and incomes.

Fiscal policy has, predictably, taken the first step of ensuring that the basic needs of most-vulnerable sections of the population are met, both during the lock-down and the ensuing period in which the economy slowly limps back to normal. The Finance Minister estimates this period to be three months. Other measures aimed at the virus-affected sectors are likely to follow.

However, the precise role of monetary policy in fighting the shock and the aftershocks of Covid-19 is somewhat fuzzy.

Yes, a large cut in the policy rate is needed and so are large infusions of rupee liquidity to ensure that the financial system is well-lubricated. The supply of U.S. dollars is scarce and the RBI will have to delve into its reserves to supply dollars to the market.

Will that be enough though? Do rate cuts and periodic liquidity infusions constitute the “whatever it takes” stand, that many economists are exhorting the central bank take? Or do we need a slew of unconventional measures?

The Fed And ECB Playbook

Recent actions of other central banks have put together a rough and ready playbook that we could take cues from. The institutional frameworks are, of course, different. Reserve Bank of India, for instance, might not be able to exactly replicate what the U.S. Federal Reserve did. However, it is possible for our central bank to take these cues in spirit if not to the exact letter.

On March 18, the European Central Bank announced its Pandemic Emergency Purchase Programme. The significance of the PEPP is not just its massive corpus of €750 billion, but the fact that it has extended the list of eligible securities to all commercial paper of financial and non-financial companies. Thus, the European Central Bank would, in effect, be a direct lender to companies to meet their working capital needs.

On March 22, the U.S. Fed went a step further and announced a number of emergency facilities. Two of them, the Primary Market Corporate Credit Facility and a Secondary Market Corporate Credit Facility, will support access to credit for large employers via the purchase of corporate debt.

It will also show forbearance, allowing borrowers to defer principal and interest payments for six months or longer at the Fed’s discretion, in order to have additional cash on hand.

Besides, like the ECB’s PEPP, the Fed now has a Commercial Paper Funding Facility in place that buys commercial paper from issuers who might otherwise have difficulty selling the paper on the market.

The Fed has also revived the Term Asset-Backed Securities Loan Facility that focuses on small businesses and households. It provides direct funding to those willing to invest in financial instrument securitisations—bundles of loans converted into a bond in lay terms—backed by small businesses and consumers. These include student loans, credit card loans, and auto loans. The U.S. central bank is also mulling over a ‘Main Street Business Lending Program’, designed to support small- and medium-sized businesses directly.

India-Tailored Solutions

A couple of lessons emerge from these initiatives.

First, the RBI cannot solely rely on a business-as-usual framework where liquidity and rate reductions do the trick of reaching affordable credit to those who need it the most. Incentives to banks like reserve requirement waivers for lending to credit-starved sectors might not be adequate.

The central bank has to consider directly providing funds to swathes of the economy where banks or investors like mutual funds fear to tread.

Direct risk-bearing could take the form of a special medium-term or long-term credit window for MSMEs and a liquidity window for NBFCs. Both the U.S. Fed’s and ECB’s measures make a strong case for direct purchases of corporate securities—both bonds and short-term instruments—by the RBI. Thus, along with the open market operations and long-term repo operations in which the RBI exchanges cash for risk-free government bonds, a third facility in which the RBI is willing to buy corporate bonds and CPs has to be created.

Besides, if the fear of default in the wake of job and income losses were to make banks wary of extending retail loans like mortgages or auto finance, the RBI could provide a backstop by offering to buy securitised tranches of these loans from banks.

The second important lesson is that regulatory forbearance is imperative. In India’s case it essentially means diluting the rigid non-performing asset norms for as long as the Covid-19 effects linger. Companies will face cash flow problems due to the unprecedented disruption in economic activity. That would lead to technical defaults.

Unless these are overlooked, the RBI can continue to infuse liquidity and slash rates, the fear of creating another pile of bad debts will stop banks from lending.

Going Outside The Box

Unconventional measures often tend to run into a legal barrier. However, in the middle of a severe crisis, the central bank cannot reject options simply because, say, the Banking Regulation Act appears to frown on it. To do “whatever”, it has to be open to innovations and find niches in the financial system where some of these special facilities can be perched. If the RBI cannot buy securitised loans directly, perhaps a large bank with a direct credit line from the RBI can buy them on its behalf.

A country’s central bank is endowed with the unique ability to absorb financial risk without having to fret constantly about the quality of its balance sheet. The RBI should play this role of risk-taker of last resort and announce some of these unconventional measures, ideally well before April 3.

Abheek Barua is Chief Economist at HDFC Bank. Views are personal.

The views expressed here are those of the authors and do not necessarily represent the views of BloombergQuint or its editorial team.