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Home >Opinion >Views >Opinion | Why RBI should now be our lender of first resort

We have by now got accustomed to the Reserve Bank of India (RBI) declaring interest rate cuts in unscheduled instalments of monetary policy. These are aimed at easing credit in the economy. The central bank’s principal tool is its repo rate, the rate at which it lends funds to regular banks. It was reduced to 4% last week, the lowest in about two decades. Not all of this easing translates into cheaper or easier loans for borrowers. This is for a variety of reasons, but perceptions among bankers of rising default risk, given the current recession, play a major role in money being less easily available than our policymakers would like. Most banks already have bad loans to worry about. Moreover, business demand for credit is held back by economic certainty. In all, few advances are being made these days. This is evident in the record sums that lenders have been lending RBI overnight via its reverse repo window. On some occasions, the figure has exceeded 7 trillion. This is money that would have earned much more by way of interest had banks lent it to clients instead. To dissuade this inflow, RBI has slashed its reverse repo rate drastically too; again, without much effect. Its usual instruments appear to have lost efficacy.

Ever since the covid crisis struck, our central bank has adopted a flurry of unconventional measures as well, mostly meant to put large tranches of money at the disposal of the banking system for disbursal or deployment. What works when an economy is looking up, though, does not necessarily have the same effect when would-be creditors and debtors are downcast. In gloomy times, debt can be a source of anxiety to both parties. Today’s big restraint on credit, thus, is not the cost of funds, but the fear that any debt advanced or taken would not be able to justify itself. A small business may not expect a return on investment higher than the interest rate on offer, for example, while a household may not see earnings rise to lighten the burden. As for bridge loans to cover routine expenses, these require the confidence that an end to the gap is actually in sight; if not, expense reduction is the usual way out. Most companies seem to have dealt with the crisis by cutting costs, not adding on debt. In a nutshell, then, a lack of market demand, revenue losses and doubts about servicing loans have joined forces to push money into safety vaults at a time it needs to get out there and move around.

To rid the economy of inertia, a burst of government spending would have helped. However, since credit systems must do most of the work, perhaps RBI needs to take a relatively radical approach. To the extent that credit risk is a deterrent to lending, it could take this risk upon itself by buying corporate bonds. If RBI cannot directly subscribe to debt issuances by India Inc. or snap up its debentures in the secondary market—since its choices would draw scrutiny—it could still ease the flow of credit to companies by opening a repo-like window for the purchase of well-rated corporate bonds from banks, which are reported to be investing heavily in these. If the central bank were to adopt such a plan, it could boost a market for private bonds that badly needs to evolve out of infancy. In a country that has been over-reliant on an inefficient banking system dominated by public sector lenders, such a dramatic shift in RBI policy might also help reform financial intermediation, per se. This may not be easy to do, but it may be worth a try.

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