Home / Opinion / Columns /  RBI must lean on forbearance in the absence of rate space

In its latest annual report, the Reserve Bank of India (RBI) has expressed concern about the irrational exuberance of stock markets. As a regulator entrusted with the task of maintaining financial stability, it is appropriate that RBI keep an eye on a possible meltdown in stocks. But it also hinted that this bubble was partly caused by excessive money supply. This is under its control and tantamounts to saying: ‘We’re concerned that our actions on the monetary front are creating conditions of financial instability.’ Should it not then hold itself back on money creation, rather than let a bubble inflate? Of course, even in the best of times, RBI’s task is one of balancing competing, and often conflicting, objectives. If it leaned towards money creation, it’s because the pandemic and lockdowns required easy money conditions and a revival of credit demand. It was practically pushing cheap money upon banks to on-lend. It has been buying government bonds, and effectively funding most of the fiscal deficit. Its money creation over the last 18 months has bloated its balance sheet by nearly 50%. Neither credit nor the economy has grown by even a fraction of that rate. Naturally, that huge stock of money supply has found its way into assets like houses and shares. This has happened globally, too, as central banks unleash unlimited liquidity.

But now there are signs that excess money is acting the old-fashioned way as well. It is leading to conventional inflation in goods and services, not just in assets. Too much money chasing too few goods. India’s wholesale price index-based inflation hit double-digits in April. It is growing at that rate almost across the manufacturing sector, including sub-categories such as metals, chemicals, plastics, paper and textiles. Internationally, the Bloomberg commodity index is up 53% over the past 12 months. Steel prices may cross $1,000 per tonne, and hit an all-time high. Copper prices are already at a lifetime record. Some of the inflation in commodities that are traded on exchanges could be reflecting speculative interest, since liquidity is in a glut. But underlying demand is also strong, fuelled by vaccine optimism. Even the Food and Agricultural Organization’s index is at a seven-year high. Edible oil prices have doubled in one year, and sugar prices are up 60%. Much of the rise in industrial commodity prices represents escalating input cost to producers, and will sooner or later be passed on to consumers, making inflation manifest itself in the consumer price index too. The only laggard, but just by a bit, is the energy group. Retail prices of petrol and diesel have been inching up in India. In the US, consumer price inflation in April clocked 4.2%, the highest in decades. Even the eurozone is showing inflationary pressures.

RBI’s monetary policy committee meets for the first time this fiscal year against the backdrop of a build-up of inflationary pressures, both domestically and internationally. But unlike in the West, where growth prospects are getting rosier, India’s growth outlook is likely to be downgraded, to possibly 8% this fiscal year. This is mainly due to the harsh and unanticipated impact of the second wave. Last year, the lockdown’s economic impact was partly offset by the resilience of rural demand. This year, that cushion is not available, notwithstanding the bumper harvest expected in cereals. The Centre for Monitoring Indian Economy has reported double-digit unemployment even as workforce participation rates have fallen to a worrying 40%. It also reported that 97% of Indians have lower incomes now than before the pandemic. By next year, the Indian economy’s size will still fall short of what it was two years ago, despite positive growth this year.

Thus, policymakers must tackle three formidable challenges: inflation, unemployment and widening inequality. Strong fiscal stimulus is needed to push up exports, capital investment and industrial growth.

What then can RBI, which has reached the limits of monetary accommodation, do? It has committed itself to buying government bonds, which amounts to an Indian version of quantitative easing. Beyond policy rate tweaks, it can increase its regulatory forbearance. First, announce a moratorium of two quarters for all small businesses below a threshold, with a clear message that the cumulative interest will be borne by the borrower. Such a moratorium should not be left to the discretion of banks, but mandated. Second, it can reduce the capital adequacy requirement for non-banking financial companies (NBFCs), because they often reach where banks don’t. A lower requirement of, say, 10% instead of 15% of assets (banks must keep a cushion of only 9%) will release capital and spur credit creation in small and unbanked segments. Since NBFCs do not accept public deposits, such forbearance is appropriate in these pandemic times. Third, RBI should consider paying interest on the cash reserves that banks place with it. They need recapitalization, and instead of capital coming via the government, this is a direct method of injecting the much-needed largesse.

Finally, while the guidelines for restructuring 2.0 announced on 5 May are welcome, RBI must ensure their implementation. Longer term effects of covid on banking will be felt next year. Just as India’s glide path for fiscal consolidation was adjusted to accommodate larger deficits, so does RBI have its work cut out. A deft combination of forbearance, loan restructuring, recapitalization and policy accommodation would help. All this, without a loss of credit discipline.

Ajit Ranade is chief economist at Aditya Birla Group.

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