Central banks across the globe have triggered emergency measures to support the economy and industry in the wake of the impact of the Covid-19 pandemic. Efforts have taken either the form of a reduction in benchmark rates, which has been done by the US Federal Reserve, or a stimulus such as the one being carried out by the European Central Bank on behalf of flailing industries.
In India, however, the country’s banking regulator, the Reserve Bank of India (RBI), seems to be sitting pretty even as the crisis has pushed the Indian currency to a record low of 75 per dollar and foreign investors have liquidated over $5 billion worth of Indian equities only in the last twenty days.
Across the globe, the central banks of the United States, Australia, Hong Kong and mainland China, South Korea, the United Kingdom, along with the European Central Bank, Germany, France, Italy, Japan and Canada have announced one or the other measures to help their economies.
Of these, the US’ Federal Reserve, the United Kingdom’s Bank of England, and Canada’s Bank of Canada lowered interest rates, while the others have rolled out multi-billion dollar packages to provide relief to their economies.
So, the big question is what makes India's banking regulator remain silent on a rate cut to support the economy amid the crisis. Right now, the key policy rate, the repo rate, at which the RBI lends to Indian banks is 5.15 percent. The RBI has brought down the repo rate from 6.50 percent to its current level within the last year. The repo rate determines the other lending rates at which banks give credit to consumers.
Ahead of RBI governor Shakitkanta Das’s media interaction held earlier this week, it was widely anticipated that the RBI too would follow the US Federal Reserve in cutting the key policy rates. That, however, did not happen. Analysts believe that there may not be an appetite for a further rate cut amid the Covid-19 gloom, as demand for consumption is not going to take place anyway, even as a former RBI governor said that he strongly believed that if the Covid-19 “crisis deepens,” a steep monetary policy relaxation may have to be resorted to. If that were to happen, the former governor warned that the repo rate could possibly plummet below historically low levels.
Sunil Sinha, Director (Public Finance), India Ratings – a Fitch Group Company, said, “Policy rate cut should eventually lead to a drop in lending, borrowing rates. In our case, the RBI has already reduced the repo rate by 135 basis points between last February and now.”
“So, the window available for RBI to further reduce policy rate is limited. If we lose this firepower now, we will be practically left with nothing if the situation worsens further,” Sinha added.
Stressing on the fact that the impact of Covid-19 on the economy “must be a part of the concern” of policymakers, a former RBI governor maintained that a deep rate cut may be required in the case of a crisis.
The former governor, who did not wish to be named, said, “One cannot insulate the economy from the negative impact of Covid-19. The economy will definitely be affected. Demand will be impacted. On the monetary side of it, reducing key rates could ensure that the pandemic has a little less impact on the economy.”
The former governor, however, warned that in case of a crisis, the key rates may have to be reduced to levels below their historical lows. The lowest level for the repo rate in India was 4.75 percent in 2008 and the highest level was 9 percent in March 2010.
No Rate Cut, But Steps Taken For Financial Stability
For now, even though the RBI has avoided a policy rate cut, it has taken several measures to ensure stability in the financial markets as continued selling by foreign institutional investors has led to a massive flight of foreign exchange, putting pressure on India's currency.
Spooked by the Covid-19 pandemic in India, FIIs have withdrawn to the tune of $5.16 billion from the Indian equity markets in the month of March alone.
On Wednesday, the RBI announced an open market operation (OMO) to purchase government bonds to stabilise financial markets. The OMO was implemented on Friday. Under the OMO, the RBI purchases government securities in the open market from Indian banks, providing them with much-needed liquidity in return.
With the conclusion of the first tranche of OMO implemented to fight Covid-19, the RBI has announced two more tranches as, in its assessment, the situation is “still severe”.
In an official statement issued on Friday, the RBI said, “The response to the open market purchase auction conducted on March 20 has been positive. Meanwhile, with the COVID-19 related dislocations, stress in certain financial market segments is still severe and financial conditions remain tight. The RBI’s endeavour is to ensure that all market segments function normally with adequate liquidity and turnover.”
“Accordingly, on a review of the current liquidity and financial conditions, the Reserve Bank has decided to conduct the purchase of Government securities under Open Market Operations (OMOs) for an aggregate amount of $4 billion in two tranches of $2 billion each in the month of March 2020. The auctions would be conducted on March 24, 2020, and March 30, 2020,” the statement added.
This is the third tool deployed by the country's apex bank this week to maintain stability in the financial markets in the country amid panic among investors.
Two other monetary tools that the bank has deployed are the Dollar-Rupee Sell Buy Swap, which is to be done on 23 March, and Long Term Repo Operations worth $13.5 billion. The currency swap window will provide an opportunity for Indian banks to bid for Indian currency in exchange for dollars to be returned to the RBI at a later date at a premium.
The LTRO worth $13.5 billion is a tool that will allow banks to lend on benchmark rates so that economic activity can continue at an abated cost in the wake of the crisis.
RBI Monetary Tools Effective in Fight Against Covid-19
Sinha believes that these measures are more effective in the fight against Covid-19 in India's current economic conditions.
“RBI has quickly moved in terms of stabilising the currency and the financial markets. That is more important aspect to deal with the current situation. At a point when city after city is coming to a halt in the country, the situation should not lead to a further halt, leading to financial breakdown," he said.
"Financial breakdown is when the money flow completely comes to a halt. The dollar exiting the Indian foreign exchange markets should not lead to a situation wherein the exchange rates hit the roof,” Sinha added.
“Stabilising the financial market by deploying monetary tools to address liquidity is a sound policy response than a cut in the key rates, as one does not know whether it will translate into credit offtake as people are risk-averse as of now,” Sinha added.
Response By Global Banking Regulators
The US Federal Reserve was the first to announce an emergency cut in the benchmark rates on 3 March amid the Covid-19 pandemic fears. The Federal Reserve again reduced the benchmark rate to a range of 0.00 percent to 25 percent. The European Central Bank was the second to announce measures without opting for a rate cut.
On 12 March, the ECB announced a stimulus worth $128 billion. On 18 March, the ECB announced a pandemic emergency purchase programme for bond buys worth $800 billion for the full year of 2020. South Korea announced a $9.8 billion stimulus package on March 3 focusing on small and medium scale businesses. The UK reduced interest rates by 0.5 percent on 11 March, while Canada too reduced rates by the same amount on 4 March.
