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Opinion | ‘Constrained discretion’ approach is the ideal way to tackle current slump

Former Fed chair Ben Bernanke said ‘constrained discretion’ rules are more effective in achieving desired goals of monetary policy.

3 min read . Updated: 06 Feb 2020, 11:09 PM ISTSoumya Kanti Ghosh

The introduction of Digital Payments Index is an excellent step and this will spread the benefits of a less-cash economy

The Reserve Bank of India’s monetary policy announcement reminds us of Ben Bernanke’s (former chairman of the US Federal Reserve) comment that ‘constrained discretion’ rules achieve the desired objective of monetary policy better than a strict rule-based approach. Constrained discretion is an approach that allows monetary policymakers considerable leeway in responding to economic shocks, financial disturbances, and other unforeseen developments but constrained by a strong commitment to keeping inflation low and stable.

In this respect, RBI’s emphasis on nuanced developments and regulatory policy changes is perhaps the best approach against the current growth and inflation conundrums. The current RBI dispensation, since December 2018, has consistently tried to innovate with flexible and innovative policies for enabling a better financial architecture. The policy announcement comes against the backdrop of the impact of coronavirus on global growth as a developing story. The virus has already surpassed the count of infection from previous outbreak of SARS. The coronavirus outbreak will significantly impact tourist arrivals and global trade. Commodities, notably oil and metals, have turned bearish. Indian commodity exports such as castor oil, cotton and groundnut may face some temporary slowdown. As mentioned, there are several analogues of constrained discretion in the policy announcement. The introduction of long-term repo operations (LTRO) for one year and 3 years, for a total amount of ₹1 trillion at policy repo rate, will bring down the cost of funds for banks without effectively cutting deposit rates. European Central Bank had used this tool back in 2011.

Interestingly, RBI had attempted longer term repos/reverse repos in the past too with little success as market participants prefer overnight operations and thus the move to replace such overnight operations with LTRO is a smart move.

Subsequent to the budget announcement, RBI has extended standard accounts of GST-registered MSMEs that were in default as of 1 January 2020. This will help around 6-8 lakh MSME units for further formalization. To boost the real estate sector, RBI has extended by a year the date of commencement of commercial operations of project loans for commercial real estate, delayed for reasons beyond the control of promoters. It is estimated that around ₹400 crore loans to commercial real estate would be benefitted.

The RBI has also allowed commercial banks the option of adjusting the incremental credit disbursed for specified sectors from their net demand and time liabilities (NDTL) from a specified date and a specified period for maintenance of CRR. This measure could potentially release ₹4,000 crore as additional lendable resources for commercial banks. While the amount is insignificant, such an adjustment is a powerful signalling device in impacting the money multiplier that has been showing a declining trend post demonetization. The increase in digital transactions has also played a critical role in the decline in money multiplier with a substitution from currency towards digital mode of payments.

The introduction of Digital Payments Index is an excellent step and this will spread the benefits of a less-cash economy. The measures regarding the interest rate derivative market will encourage non-resident participation and improve transparency by having better regulatory oversight going forward.

Since banks are currently participating in reverse repo owing to surplus liquidity, the time is opportune to introduce the standing deposit facility (SDF) as it comes with the conditionality of no collateral of G-Secs and will free up securities from SLR holdings and, hence will lead to an increase in demand for bonds and lower yields, and will also ensure a lower supply of government bonds through less issuance of cash management bills.

The author is group chief economic adviser, State Bank of India. The views expressed here are personal.