Opinion | Restructuring to cushion impact on the economy2 min read . Updated: 07 Aug 2020, 05:45 AM IST
RBI will have to remain vigilant of impending risks to growth and inflation, be ready to act
With inflation above its tolerance band of 6%, monetary policy committee (MPC) members, through a unanimous vote, decided to keep policy rates unchanged, while maintaining an accommodative stance. The Reserve Bank of India (RBI) has kept room to reduce rates when inflation moves towards its target of 4%, which may happen as soon as November as per the current trajectory.
With moratorium on loans ending on 31 August, RBI said the way forward is a restructuring package for businesses and households. Recent data released by large banks (55% market share) shows that there has been a sizeable reduction in moratorium in June from 50% in April for all scheduled commercial banks (SCBs). As economic activity normalizes further, the need for restructuring will be even lower.
The economy will settle down at lower than pre-covid levels in the near term. Most indicators—manufacturing and services PMIs (purchasing managers’ index), electricity output, vehicle sales, exports, imports—point to economic momentum settling at 10-15% below covid levels in the near-term. For instance, electricity demand was 92% of pre-covid level in July compared with 75% in April. GST collection is at 86% of pre-covid levels.
The RBI’s consumer confidence survey—gauge of consumer spending—was at its lowest in May, and the one-year outlook is not promising, implying that consumption demand, especially discretionary demand, will be far lower. With muted consumption, capacity utilization, which had fallen to 68.2% last December, has fallen further in the last few months.
Thus, investment demand is not likely to see upward momentum in the near term, even with lower interest rates. An economic slowdown of such proportions leads to increase in risk premium. With rating upgrade to downgrade ratio of corporate sector falling to 0.05 as in May from a high of 1.11 in December 2018, spread between 3-year AAA corporate bonds and sovereign bonds rose to 276 basis points on 26 March. It has since fallen to 50bps. This was possible because of the abundant liquidity made available by RBI and credit enhancement provided by the government.
RBI and the government will have to work together to revive demand. Centre has already expanded its gross borrowing to ₹12 trillion. Even with net tax collections at 53% of last year’s levels, the Centre has increased its spending by 13% over 2019-20. There isn’t a better time to apply Keynesian economics than now. Global central banks have become large buyers of sovereign debt to support the larger roles being played the governments. In India, too, the Centre and states will have to spend to crowd-in private sector spending.
RBI’s role will be important not only as the lender of last resort, but also as a buyer of government securities. As India’s central bank comes towards the end of its interest rate reduction cycle, it will have to navigate the economy through financial and macroeconomic stability. It has carried out its function as a central bank well, and brought a semblance of stability to financial markets. It will have to do the same in the sovereign bond market. More importantly, it will have to remain vigilant of impending risks to growth and inflation, and be ready to act.
The author is chief economist with Bank of Baroda