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Was RBI’s liquidity push what the financial markets needed?

The consecutive rate cuts by RBI are aimed at injecting more liquidity to the market.

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Last Updated: May 22, 2020, 06.23 PM IST
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The economy is passing through unprecedented tough times, and banks are acting vigilantly to prevent another episode of NPA swell.
By Deepthi Mary Mathew

Though the timing of RBI’s Monetary Policy Committee (MPC) meeting came as a surprise, the announcements made by the governor were more or less in line with expectations. It was anticipated that the MPC meeting scheduled for June 3-5 would deliver such a rate cut. The meeting, which was advanced to May 20-22, decided to cut the repo rate by 40 bps to 4 per cent.

The consecutive rate cuts by RBI are aimed at injecting more liquidity to the market. Apart from the rate cuts, the central bank has also announced Rs 8.04 lakh crore worth of liquidity-boosting measures so far.

Currently, liquidity is not the issue for financial markets, risk aversion is. There is substantial liquidity in the banking system, but risk aversion among banks is creating hindrance in increasing credit flow and ensuring transmission of rate cuts.

Banks alone cannot be blamed for turning cautious on lending. The economy is passing through unprecedented tough times, and banks are acting vigilantly to prevent another episode of NPA swell.

The Finance Minister’s announcement of Rs 3 lakh crore collateral-free loans for businesses, including MSMEs, could encourage banks to step up lending as such advances will have full government guarantee.

Similarly, in Friday’s announcement, RBI raised the group exposure limit for banks from 25 per cent to 30 per cent. That would enable corporates to meet funding requirements through bank borrowing.

These measures could push banks to scale up lending. However, given the uncertain economic situation, it remains to be seen whether these measures can actually get translated into higher credit offtake.

Another major announcement was with regard to the extension of moratorium on loan repayment by another three months. The RBI governor also announced conversion of moratorium interest payment into a term loan payable in the course of FY21. These measures could bring relief to the borrowers, but not for the banks, as there will see more pressure on balance sheets.

As expected, food inflation turned out to be the elephant in the room. Amid the lockdown and supply disruptions, food inflation rate increased to 8.6 per cent in April. If food inflation is not brought into control, it would result in a double-whammy for RBI. The central bank has a mandate for inflation targeting, with CPI as the nominal anchor. Food and beverages have a share of around 45 per cent in CPI. Thus, if the food inflation rate doesn’t fall back to a comfortable range, RBI will have to deal with an economy facing high inflation rate and growth slowdown.

Though RBI has refrained from providing any figure for projected GDP expansion for FY21, it projected a negative growth rate for FY21. A negative GDP growth rate can have a huge fiscal impact. As per the FRBM act, the fiscal deficit target is estimated as a per cent of GDP. In the current scenario, the numerator would be large considering the widening of deficit. And, the denominator would be small with the projection of a negative growth rate for FY21. Thus, the fiscal deficit as a per cent of GDP would settle at a higher range, and it may even touch the double-digit mark.

By maintaining an accommodative stance, RBI signalled that there would be more rate cuts in the future. Considering the fact that there is substantial liquidity in the banking sector, RBI could have reduced the quantum of the rate cut.

The central Bank is not short of instruments when it comes to stimulating the economy. By cutting interest rate to near zero per cent, US Fed has exhausted its option within the interest rate mechanism, when its effectiveness was limited on the economy. Unlike the central banks of other developed economies, RBI has its limitation in using unconventional monetary policy instruments such quantitative easing (QE). In such a scenario, right policy decision at the right time is critical for the economy.

(Deepthi Mary Mathew is Economist at Geojit Financial Services. Views are her own)
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(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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