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Fed’s urgent rate cuts should spur RBI to follow suit

Reserve Bank of India Governor Shaktikanta Das, flanked by deputy governors, addresses a press conference, at RBI headquarters in Mumbai (Photo: PTI)Premium
Reserve Bank of India Governor Shaktikanta Das, flanked by deputy governors, addresses a press conference, at RBI headquarters in Mumbai (Photo: PTI)

  • The US Fed dropped its key interest rate to virtually zero, its second emergency rate cut in under two weeks, and launched a $700 billion quantitative easing programme on Sunday
  • Mint explains how the Fed is combating the economic effects of the coronavirus spread

What strategy is being adopted by the Fed?

The Covid-19 pandemic has disrupted the global economy and forced businesses to halt or curtail operations. Aviation, tourism and restaurant-related businesses, in particular, are at risk of bankruptcy. In turn, they threaten the solvency of businesses and consumers dependent on these sectors. So, the Fed plans to flood the global financial system with cash. This will limit disruptions in financial markets and keep them running. Banks will be able to keep credit flowing to businesses and consumers, keeping them solvent. Towards this goal, the Fed cut its key interest rate to virtually zero and launched the QE programme.

How will this move help consumers?

The economic fallout of Covid-19 will include reduced incomes. US consumers’ spending is a key driver of the global economy. The world economy was sluggish even before it was hit by the virus. Therefore, the Fed wants to make sure US consumers remain solvent and continue to spend money. While the central bank does not have the tools to directly reach individuals, businesses and out-of-work people, maintaining credit flows helps them indirectly. Mortgage rates have fallen, releasing purchasing power. Lower borrowing costs and credit availability will allow affected businesses to keep paying salaries.

What should the Reserve Bank of India (RBI) do?

While softening vegetable prices have taken the pressure off inflation, supply-side disruptions may cause shortages and spur prices. On balance, RBI’s monetary policy committee should announce an emergency rate cut. RBI must maintain easy liquidity and ensure credit flow to those at risk of insolvency as banks will remain reluctant to lend.

(Graphic: Paras Jain/Mint)
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(Graphic: Paras Jain/Mint)

What are other major central banks doing?

Lockdowns can freeze markets. Payments may get held up and assets may be converted into cash. Markets freeze when people hold on to cash in a big way. Frozen markets can trigger asset-liability mismatches. This can exacerbate the weakness and endanger jobs. The Fed has joined forces with major central banks—the Bank of England, European Central Bank, Bank of Japan, Bank of Canada and Swiss National Bank—to guarantee that the global financial system has enough cash to continue operating smoothly.

Will the Fed’s move help in this situation?

Yes, but not majorly. After the 2008 global financial crisis, capital cushions of over $4 trillion were created at the largest US banks. The Fed wants banks to use those buffers to offer loans. It has cut to zero the reserves banks need to hold. None of this may spur new borrowing unless backed by fiscal policies of the US administration. People will watch as the crisis unfolds before taking loans. With long-term rates at historically low levels, QE may not be as effective.

Puja Mehra is a Delhi-based journalist.

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