Coronavirus Response: RBI’s Nuclear Options
There are now 471 locally-detected cases of the coronavirus in India. The fear of a further spread and the experience of countries like Italy and the United States has prompted Indian authorities to move quickly towards a near lock-down across the country.
States have shut non-essential businesses, urban transport has been restricted. The central government has asked that domestic passenger flights be stopped from the midnight of March 24. International passenger flights have already been curtailed.
It is now clear that the economy is approaching a “sudden stop”, as Sajjid Chinoy, chief India economist at JPMorgan termed it. The impact on citizens and businesses will be sudden, sharp and material, he had cautioned.
That impact is already starting to play out and, as it does, the Reserve Bank of India will have to step up its response.
The Story So Far
So far, the RBI’s approach has been to attack any signs of dysfunction arising in different parts of the market.
It started with announcing and conducting $4-billion in forex swaps designed to provide dollar liquidity at a time when dollars are rushing out of all emerging economies. The shortage of dollars was a real risk and the RBI moved to tackle that.
Then came concerns that banks will start to hoard liquidity, reducing even the minimal lending that was taking place. To counter that, the central bank announced long-term repo operations of Rs 1 lakh crore. Shorter term liquidity is being provided via the repo window. Whether banks use this liquidity to lend is an open question but the rising risk aversion will mean that bank credit flow will remain weak.
Meanwhile, the heavy outflow of foreign portfolio money from the debt markets pushed up both government and corporate bond yields. To ensure there is a buyer who steps in to fill the gap left by foreign investors, the RBI announced Rs 40,000 crore in bond purchases under its open market operations.
While an emergency interest rate cut has not yet been announced in India, the Monetary Policy Committee is widely expected to cut rates when it meets in April.
But as the shut down worsens, these steps may not be enough. The central bank will at least have to dust off some of its nuclear options in case they need to be used.
The Nuclear Options
The first of these options is announcing forbearance for loan defaults. While the RBI has selectively offered forbearance to stressed sectors in the past, it has stayed away from a broad-based loosening of bad loan classification norms for more than a decade.
It seems inevitable that the RBI will need to offer some relief on asset classification. That will be the first of its tough calls.
The second will be on ways to provide support to the corporate debt markets.
The RBI so far only accepts government bonds as collateral for lending via its liquidity adjustment facility. It takes no credit risk in the process. Should it become necessary, the central bank may have to accept commercial paper and corporate bonds as collateral. This would widen the spectrum of businesses the RBI can provide relief to.
At the time of the global financial crisis, the RBI had opened a specific liquidity line for mutual funds to avoid forced liquidation. If conditions worsen, the central bank may have to consider some such measures.
The RBI has another option. A truly nuclear option, so far unused at least in the post liberalisation period. Section 18 of the RBI Act allows the central bank to directly discount bills if need be.
The section titled ‘Power of Direct Discount’ reads:
When, in the opinion of the [Bank], a special occasion has arisen making it necessary or expedient that action should be taken [under this section] for the purpose of regulating credit in the interests of Indian trade, commerce, industry and agriculture, the Bank may, notwithstanding any limitation contained in section 17:
- Purchase, sell or discount any bill of exchange or promissory note though such bill or promissory note is not eligible for purchase or discount by the Bank under that section;
- [or] make loans or advances to – (a) a State co-operative bank, or (b) on the recommendation of a State co-operative bank, to a cooperative society registered within the area in which the State cooperative bank operates, or (c) any other person, repayable on demand or on the expiry of fixed periods, not exceeding ninety days, on such terms and conditions as the Bank may consider to be sufficient.
The RBI may not choose to use this option since the logistics of getting such a facility may lead to inordinate delays in providing relief. Liquidity lines via banks, particularly public sector banks, may be quicker to put in place if needed.
Finally, the RBI will also need to step in to aid the government. Most economists believe that there is no option but for the government to support the economy. “For a revival in growth, large fiscal support will be needed,” said Neelkanth Mishra, India strategist at Credit Suisse.
To provide this support, the government may need to borrow more. Should this additional borrowing be large, RBI may need to conduct open market operations to the tune of Rs 1 lakh crore. Beyond that, the RBI may need to consider the need to step back into direct monetisation.
Over the coming days and weeks, the central bank will likely be presented with a number of tough choices. It will need to act deftly to limit emerging risks. But it will likely do so in a manner that doesn’t set a poor precedence.
The nuclear options are available. The central bank will have to choose wisely on whether to use them or not.
Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.