The Reserve Bank of India (RBI) announced its October Monetary policy statement, and has done its best to calm the nerves of the market and the economy by painting a picture of hope for recovery. The RBI expects real GDP to decline 9.5% in 2020-2021, “with downside risks.”
The policy rate and the repo rate are kept unchanged at 4.00% and 3.35% respectively, as are the permanent marginal facility (MSF) and bank rates at 3.35%. The Wholesale Price Index (WPI) has shown a slight upward trend, mainly propelled by higher prices for primary items in recent months. Thus, leaving rates unchanged was widely expected, as the central bank would like to have some flexibility to act in the future if the economy becomes inflationary. The RBI, however, expects food prices to fall, thanks to good kharif production.
The central bank has ensured both the market and the government to create comfortable liquidity conditions so that private and public borrowing is not hampered in any way. The following major liquidity improvement announcements were made.
To revive activities in specific sectors with both backward and forward linkages and multiplier effects on growth, the RBI introduced Targeted Long Term Repurchase Transactions (TLTROs) with mandates of up to three years for a total amount of up to Rs. 1 lakh crore, at a variable rate linked to the policy’s repo rate. The liquidity made available by banks under this program must be deployed in corporate bonds, commercial paper and non-convertible bonds issued by entities in growth sectors.
· The liquidity made available by these TLTROs can also be used to grant bank loans to growth sectors. Banks that have raised funds under previous TLTROs will have the option to cancel these transactions prior to maturity. This is done to ensure a smooth and transparent credit operation by the banks.
· Reacting to “comments from market participants”, the central bank also decided to increase the size of special open market operations (OMOs) to Rs 20,000 crore.
· To facilitate liquidity of State Development Loans (SDLs), the RBI will conduct OMOs in SDLs as a special case during the current fiscal year. The umbrella bank hopes to facilitate efficient pricing by undertaking these transactions.
Although there is no restriction on the maximum duration of repo transactions, these transactions are generally undertaken for a period of one week. The extension of the period to three years is intended to allow banks to grant new loans to the sectors concerned.
Simply put, previously commercial banks would borrow money from the RBI for a very short period of time to overcome the immediate liquidity issues they faced. Now, more RBI funds will be available to banks for a much longer period at the repo rate. Thus, low interest rate loans (assuming the pension rate remains at a lower level) will be available for “growth oriented” sectors.
For government development loans, however, the cost of borrowing is expected to be higher as these will be raised through open market operations. Now the question we can ask ourselves is: how do all of these elements contribute to the economic recovery?
The idea that increasing the supply of credit will facilitate economic recovery has been circulating for some time. The massive contraction of GDP induced by the pandemic has only accelerated the clamor. The underlying logic is simple: the provision of loanable funds at low cost will increase credit underwriting, the loans taken (industrial, personal or other) will then be used in new economic activities and will ultimately lead to recovery and growth. increased. But looking at the trends in key pension rates and the credit-to-deposit ratio over the past year, one is bound to be skeptical.
The credit-to-deposit ratio shows how much of each rupee of deposit is given as an actual loan disbursement. Overall, this is one of the basic indicators of credit growth. Although the policy rate for pensions has steadily declined in recent years, the credit-to-deposit ratio has remained constant and, since April of this year, has fallen during the pandemic (Figure 1). Although the cost of borrowing steadily declined and more credit was made available to the economy, there were very few takers for such loans.
The collapse in credit demand becomes visibly significant when looking at the trends in the incremental credit-to-deposit ratio. As the name suggests, this ratio shows how many new deposits are made in the form of new loans in the economy. This ratio was in negative territory between July and September of last year, then slowly recovered to a level of around 60% in March 2020, only to fall back into the negative zone. For comparison, the value of this ratio was 169.70% on December 21, 2018, 126.29% on January 18, 2019 and 116.01% on March 15, 2019.
The growth rates of deposits have been fairly stable even during the pandemic, but there has not been a commensurate growth in credit. The additional credit-to-deposit ratio figures only reaffirm this phenomenon and this trend began long before the pandemic.
Therefore, it is the demand for credit that is the problem, not the supply of credit. If there are few economic actors in the system interested in receiving credit and using it in productive activities, no additional amount of credit will solve this problem.
If the disease is rooted on the demand side, then monetary remedies rarely work. Only fiscal solutions can remedy distortions on the demand side. The time has come to seek these avenues.
The opinions expressed above belong to the author.
The Observer Research Foundation
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Posted on: Wednesday October 14th, 2020 6:05 AM IST