Dear governor, why save the bullet? Use it now

Beyond perking up the economy, the RBI needs to ensure proper functioning of the bond market, the credit market and the larger financial system

On March 8, Uday Kotak, executive vice-chairman and managing director of Kotak Mahindra Bank Ltd, tweeted: “Coronavirus roils global financial markets, sparking chatter of coordinated monetary easing by central banks. Reminds me of Mark Twain’s quote, 'To a man with a hammer every problem looks like a nail’.”
 
It got a huge response — 15,700 likes and 3,800 retweets.
 
Clearly, there are many takers for Kotak’s belief. But central banks globally don’t seem to care much about Mark Twain. In March, at least 15 central banks have cut their policy rates, starting with the Reserve Bank of Australia. The list includes the US Federal Reserve (US Fed) and the Bank of England (BoE) besides the central banks of Canada, Malaysia, Hong Kong, Argentina, Saudi Arabia, Bahrain, Moldova, Macao, Jordan, Kuwait, Mauritius and Iceland. The central bank of China has cut the commercial banks’ cash reserve ratio to release $78 billion.

 

At least two of them have gone for out-of-turn rate cuts — the US Fed and the BoE.
 
On March 3, the US Fed was the first central bank to take the emergency step of half a percentage point cut to limit the economic and financial fallout from the coronavirus — its first such out-of-turn action since late 2008, in the aftermath of the collapse of Lehman Brothers Holdings Inc.
 
At a special meeting that ended on March 10, the Monetary Policy Committee of the BoE unanimously voted for policy rate cut by half a percentage point. It also announced a new term-funding scheme to support small and medium companies and measures to help commercial banks lend more on a day the government presented the budget, raising public borrowing.

 
The only central bank that has met recently but left its rate untouched is the European Central Bank (ECB). Last week, it decided against a rate cut but announced measures to support bank lending and expanded its asset purchase programme by $135.28 billion. Anyway, the ECB’s main rate remains in the negative zone (-0.5 per cent).
 
After a half a percentage point cut earlier this month, the benchmark Fed-funds rate is now in the range of 1-1.25 per cent. The Fed will surely cut rate again when its rate-setting committee meets on March 17-18. Many say it may not wait till then and go for an emergency cut before the meeting. They don’t rule out the benchmark rate dropping to zero over the next few months.

 
Meanwhile, the Fed has launched a series of massive cash injections into the funding markets and begun buying government bonds even as the 10-year treasury yield has plunged to its historic low.
 
The Fed is known to supply steroid to the stock market. What should the Reserve Bank of India (RBI) do? I don’t doubt that there will be a rate cut when its Monetary Policy Committee (MPC) ends its three-day meeting on April 3 but shouldn’t governor Shaktikanta Das roll up his sleeves and call the meeting now?
 
He can do so. Under Section 45ZI of the RBI Act, there must be at least four MPC meetings a year; the schedule needs to be published at least a week ahead of the first meeting. The dates can be changed and the governor can decide to have additional meetings for “administrative exigencies”.

 
Why should there be a rate cut? Like most other nations, Asia’s third-largest economy too is being affected by Covid-19. The service sector is bearing the brunt and exports are being hit. There has been no demand for investments and no signs of any pick up in credit demand. On top of that, the financial sector is not in the pink of health.
 
India’s retail inflation dropped to 6.58 per cent in February, below the consensus estimates, and against the 68-month high of 7.59 per cent in January. The drop has been driven by a sharp fall in food inflation; the so-called core inflation too moved southwards. The dramatic fall in crude prices will put pressure on inflation further in the coming months and the average retail inflation in 2021 could be 5 per cent or even less. In its February policy, the RBI estimated 5.4-5 per cent inflation for the first half and 3.2 per cent for the third quarter of 2021.

 
The latest set of data on inflation and industrial production was released last week. The MPC won’t have any fresh data on its table before the April policy. Why wait then? Let it go for a 0.40 per cent cut and bring the policy rate down to 4.75 per cent for now, the level of April 2009 — when we saw the last of a series of rate cuts that had started in July 2008 to contain the impact of Lehman collapse in India.
 
A rate cut is on the cards. The RBI’s first Rs 25,000 crore long-term repo auction drew Rs 1.94 trillion bids on February 17; for the next, on February 24, the bids dropped to Rs 1.23 trillion and for the fourth and last auction on March 9, the bids were for Rs 48,000 crore. The swap rates are also coming down, making it unattractive for banks to borrow from the RBI at 5.15 per cent, its policy rate.

 
Incidentally, in 2008, India was far better off — the economy was growing at over 9 per cent, bank credit growth was almost three times the GDP growth and the financial sector was rock solid. Now, we have problems on all three fronts. And, both the fiscal and the monetary space is too limited to support the economy.
 
Last week, the RBI announced six-month US dollar sell/buy swaps to provide liquidity to the foreign exchange market. The central bank also said it is ready to take all necessary measures to mitigate the effects of the coronavirus pandemic on the Indian economy and ensure normal functioning of the financial markets and institutions.

 
It’s time to walk the talk. An out-of-turn policy rate cut should accompany assurance of RBI’s bond buying from both the primary and the secondary markets and the reopening of a short-term repo window from where banks can borrow money from the central bank. There is about Rs 3 trillion excess liquidity in the system but banks are cutting down risks; there could be serious dislocations unless the RBI acts. Beyond perking up the economy, RBI needs to make sure proper functioning of the bond market, the credit market and the larger financial system. Why save the bullet, Mr Das? Use it now.

 
The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd.
 
Twitter: @TamalBandyo