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Home >News >India >Relief package measured and targets population segments most affected: Former RBI governor D Subbarao

In September 2008, when the global economy was thrown into a vicious financial crisis, India’s central bank went all out to protect its economy. Duvvuri Subbarao, who was Governor of Reserve Bank of India (RBI) at that time believes that the current crisis triggered by Covid-19 outbreak is complicated and policy measures should be tailored accordingly rather than being a copy of those taken during the financial crisis.

Excerpts:

First off, what do you think of the Finance Minister’s Relief Package announced a short while ago?

I’ve barely had time to absorb the details of the package. But my first reaction is that it is measured and targets population segments most affected by the lockdown – migrant workers and urban and rural poor. It’s Rs.1.7 trillion which, if my arithmetic is right, translates to about 0.8% of GDP. How this will be financed is not yet clear. To what extent will it be financed by reallocation from other expenditures and to what extent by the cushion provided by the drop in the price of oil? Is the government temporarily suspending the FRBM?

In all relief packages, it’s important to remember Keynes’ dictum: “There is nothing more permanent than temporary government programme." So, tying down these reliefs to the period of the shutdown is important. Also, the package does not contain any relief for MSMEs and other hard-hit sectors facing cash flow problems. Will there be another package for them?

How different is the current crisis from the global financial crisis and should the responses be different as well?

This crisis is different from the global financial crisis (GFC) of 2008 in important ways. The GFC was a result of excesses in the financial sector which transmitted to the real economy. In contrast, this crisis stems from a collapse of supply and demand in the real economy which is transmitting to the financial sector. Second, this crisis is more complicated because there are too many known unknowns, not to speak of unknown unknowns. Just to cite one example, the stronger the shutdown, the stronger will be the chances of containing the pandemic. But stronger also will be the negative economic impact. How the positives and negatives of this cruel paradox balance out is an unknown. Finally, for India, the macroeconomic context is different from that in 2008. Back then, our growth was robust and the fiscal headroom was not so constrained. This crisis hit us when growth is in a slump and the fiscal situation is dire.

Do central banks have a standard operating procedure? Does RBI have one?

After the 2008 crisis, most central banks prepared standard operating procedures (SOPs) for managing financial crises in accordance with BIS (Bank for International Settlements) guidelines. RBI too has them.

But the SOPs have to be adapted to the context of each crisis. For example, back in 2008, central banks eased aggressively, cutting rates and unleashing quantitative easing. It worked then because faith in the financial sector was broken. It’s not clear aggressive easing is the most appropriate strategy now since the panic in the markets stems from fear and uncertainty about the virus which is unlikely to be allayed by easy money.

Are you suggesting that the liquidity being pumped in by RBI is unwarranted?

Not at all. Providing liquidity in times of crisis is like giving first aid. To that extent, the OMOs (open market operations) and the LTROs (long term repo operations) by the RBI are appropriate. RBI is also supplying dollar liquidity. What I am suggesting is that copying the 2008 template to the dot without any consideration to the context is inappropriate.

Is providing liquidity enough, though? The market seems to think a lot more is needed, maybe deep rate cuts?

A rate cut is important but that is not the first line of defence right now. In fact, the binding constraint right now is not even liquidity. The binding constraint is risk aversion. Burdened with poor asset quality, banks, particularly public sector banks, are not prepared to take on risk without some guarantee or credit enhancement backup. Going back to 2008, we provided a dedicated line of credit to banks to backstop mutual funds and lent to a SPV floated by the IDBI to support NBFCs. What’s important to note that these backstops were barely used; their mere existence inspired market confidence. On similar lines, the priority for the RBI is to come up with instrumentalities to ensure flow of credit to vulnerable sectors.

Does that mean macro-prudential measures are the answer?

Largely yes. In general, it’s not a good idea for central banks to do sectoral interventions. But crisis times call for flexibility and ingenuity.

RBI invented macro-prudential measures before they even had a name. There is a case for macro-prudential measures to support sectors that are most hurt by way of, for example, adjustment to risk weights and LTVs (loan to value ratios). Selective forbearance on asset classification also falls into this category. Where necessary, the government should step forward to extend credit guarantees. Of course, broad spectrum measures, in addition to sectoral measures, are also needed.

So in your opinion, the RBI should save its powder on rate cuts for later?

Rate cuts and pumping in liquidity work when there is transmission. In fact an ill-timed rate cut can be counterproductive. A failed rate cut, that is one which does not transmit, can be worse than no rate cut at all.

For sure, RBI will need to cut rates but that will be most effective when the lockdown is lifted and the economy gets into a recovery mode. For now, it will be best to focus on measures to ensure credit flow to sectors that are most in need.

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