The Reserve Bank of India (RBI) announced its October Monetary Policy statement, and tried its best to calm nerves in the market and economy by painting a hopeful picture of recovery. The RBI expects the real GDP to decline by 9.5 per cent in 2020-21, “with risks tilted to the downside”.
Policy repo rate and reverse repo rate are kept unchanged at 4.00 per cent and 3.35 per cent respectively and so are marginal standing facility (MSF) and bank rates, at 3.35 per cent. The wholesale price index (WPI) showed a slightly upward trend, mainly propelled by a rise in prices of primary articles in recent months. So, leaving the rates unchanged was widely expected, as the Central bank would like to have some flexibility to act in future if the economy turns inflationary. The RBI, however, expects food prices to fall, riding on a good kharif production.
The Central bank assured both the market and the government of creating comfortable liquidity conditions so that private and government borrowing are not hampered in any way. The following major liquidity enhancement announcements were made.
· To revive activities in specific sectors with both backward and forward linkages and multiplier effects on growth, the RBI has introduced on-tap targeted long-term repo operations (TLTRO) with tenures of up to three years for a total amount of up to Rs. 1 lakh crore, at a floating rate linked to policy repo rate. Liquidity availed by the banks under this scheme has to be deployed in corporate bonds, commercial papers and non-convertible debentures issued by entities in the growth-oriented sectors.
· The liquidity availed by these TLTROs can also be utilised to extend bank loans to the growth-oriented sectors. Banks which have raised funds under earlier TLTROs will be given the option of reversing these transactions before maturity. This is done to ensure smooth and seamless credit operation by the banks.
· Reacting to “feedback from market participants”, the Central bank also decided to increase the size of special open market operations (OMOs) to Rs 20,000 crore.
· To facilitate liquidity to state development loans (SDLs), the RBI will conduct OMOs in SDLs as a special case during this current financial year. The apex bank expects to facilitate efficient pricing by undertaking these operations.
Though there is no restriction on the maximum period of repo operations, usually these operations are undertaken for a period of one week. Extending the period to three years is intended to enable the banks to extend further loans to the relevant sectors.
In simple words, earlier, commercial banks would borrow money from the RBI for a very short period to overcome any immediate liquidity challenges they face. Now, more funds from the RBI will be available to the banks for a much longer period at repo rate. So, low-interest loans (assuming that repo rate will continue to remain at a lower level) will be available for “growth-oriented” sectors.
For state development loans, however, the cost of borrowing is expected to be higher as those will be raised through open market operations. Now the question that one may ask is — how do all these help in economic revival?
The idea that increasing credit supply will facilitate economic revival has been doing the rounds for quite some time. The pandemic-induced massive GDP contraction has only accelerated the clamour. The underlying logic is simple — making available low-cost loanable funds will increase credit off-take, those credits taken (industrial, personal or otherwise) will then be utilised in new economic activities, and will finally result in heightened revival and growth. But, looking at the trends in the policy repo rates and credit-deposit ratio in the last one year, one is bound to be sceptical.
The credit-deposit ratio shows how much of each rupee of deposit is extended as actual credit disbursal. Broadly, this is one of the basic credit growth indicators. Though policy repo rate has been continuously falling in the last few years, the credit-deposit ratio has remained constant and since April this year, has plummeted during the pandemic (Figure 1). Though the cost of borrowing has consistently fallen and more credit was made available to the economy, there were very few takers for such loans.
The slump in credit demand gets visibly prominent if we look at the trends in incremental credit-deposit ratio. As the name suggests, this ratio shows how much of new deposits are extended as new credit in the economy. This ratio was in the negative territory in the period between July and September last year, then slowly revived to a level of around 60 per cent in March 2020, only to slump into the negative zone once again. To provide a contrast, the value of this ratio was 169.70 per cent on December 21, 2018, 126.29 per cent on January 18, 2019, and 116.01 per cent on March 15, 2019.
Deposit growth rates have been quite steady even during the pandemic, but there was no commensurate growth in credit. Incremental credit-deposit ratio figures only re-affirm that phenomenon and this trend started much before the pandemic.
Therefore, credit demand is the problem, not credit supply. If there are few economic actors in the system interested in availing credit and employing it in productive activities, no amount of additional credit supply will be able to solve that problem.
If the malady is entrenched on the demand side, then monetary remedies seldom work out. Fiscal solutions only can take care of the demand-side distortions. The time has come to look for those avenues.
The views expressed above belong to the author.
The Observer Research Foundation