RBI can look at direct bond purchases from govt: D Subbarao

RBI can look at direct bond purchases from govt: D Subbarao

The extraordinary conditions caused by the economic fallout from the spread of COVID-19 creates a case for the Reserve Bank of India to consider buying government debt directly from the primary market, as borrowing will have to rise to manage the response to the crisis, former RBI governor D. Subbarao said.

AgenciesUpdated: Wednesday, April 15, 2020, 02:09 PM IST
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"There is a provision for Reserve Bank of India to directly finance the government through a primary issue... I would think that because this is such an exceptional situation, because this such a deep crisis, this is the time, if at all, to invoke that exceptional provision, and for Reserve Bank of India to directly buy government debt from the primary market," he said in a webinar on Sunday.

A video of the webinar conduced by the CFA Society has since been posted online. Noting that this was a real economic crisis that was spilling over into the financial sector and so not like in 2008, Subbarao felt that central banks needed to be circumspect on using their firepower as the aim is not to restore faith in the financial sector, but to restore faith in the real economy. In this context, Subbarao pointed out that when the global financial crisis happened in 2008, the Indian economy was growing at a stronger pace, the fiscal position was better to enable spending for a stimulus, the financial institutions didn't have a debt overhang and there was more space available within monetary policy.

On all these counts, India is in a worse position now, with the only silver lining being that its external position, with robust foreign exchange reserves and currency are better placed now than they were in 2008, he added. He supported the RBI's decision to infuse liquidity into the system, and called it the classic response of any central bank in a crisis. Like oxygen is first administered to a patient admitted to a hospital, central banks like RBI necessarily have to provide more liquidity when faced with a crisis, so that government, banks and the real economy can borrow, he said. He said there were some people who felt that even the large 75-basis point cut in rates in end-March was unnecessary in the absence of monetary policy transmission, and that Reserve Bank of India should have saved that firepower for later.

However, Subbarao believes that the repo rate reduction was done to ensure banks remained supported both with liquidity and with cheaper funds, so that financial stability was maintained. "I think the real policy rate is still positive so there is some room for Reserve Bank of India to cut rates." "The question is, is cutting rates necessary and will cut in rates be effective... to the extent that Reserve Bank of India has cut, I think it was necessary but I think they should be circumspect about further rate cuts, as they will not be as effective as past rate cuts. In fact, the marginal impact of additional rate cuts may even be lower," he added.

Subbarao said non-performing assets of financial institutions are already at 9-10% now, and set to grow further as a fallout of the COVID-19 crisis. He added that it is not clear if these institutions would be able to handle the impact of the "significantly higher level" of stressed loans that will emerge. He batted for some creative destruction during the crisis, and said that while there should be support for 'illiquid' institutions, 'insolvent' institutions must be allowed to fail. Subbarao said the government will have no choice but to recapitalise banks so that they can support the recovery from the crisis. Despite delays in the Insolvency and Bankruptcy Code resolutions, he hoped that with most legal-technical issues being already cleared, this mechanism would speed up resolution and recovery.

On non-bank finance companies, Subbarao noted that there was a line of credit offered via banks, and a special purpose vehicle created in 2008, and he expects RBI to provide such "special support" so that non-bank lenders can in turn support smaller borrowers. Subbarao said there are central banks such as the US Federal Reserve that do buy corporate bonds, while some traditional central banks, including the RBI don't buy non-sovereign bonds. He felt that Reserve Bank of India buying corporate bonds or commercial paper to support non-bank lenders or companies, should only happen after exhausting all other possible measures, and as an exceptional case.

The lockdown at an early stage of the spread of COVID-19 in India has helped prevent a "raging fire and make it more of a slow burn". He said India will have to chart out its own course, its response to the COVID-19 risks, based on our population, density of population, fiscal constraints, and not just copy what other countries are doing. On fiscal deficit, he said the position was "over stretched" currently with combined deficit of the Centre and the state governments already exceeding 10% of GDP, and so governments must be careful on how they plan their crisis response. Subbarao said there is pressure on the governments to spend more, even at the cost of taking fiscal deficits to unprecedented levels, just like many advanced economies are doing. If fiscal deficit is already at a 10% level, then it can lead to a rise in interest costs with private investment getting crowded out, and there can be pressures on the currency and even on the inflation front. He said there could be a sovereign debt downgrade, which could lead groups have rating bars on their investment to make exits. He was not a fan of people advocating 'boot-strap financing' that does not look at fiscal deficit at all, and advocates spending to grow your way out of the crisis. The other option was to set a limit of 2-3% of GDP, and contain your expenditure for the stimulus to this level and prioritise putting money in the hands of people and firms.

Subbarao suggested that the government should release pending payments to large companies, on the condition that they clear dues to micro, small and medium enterprises. It could also provide guarantees to credit given by banks, who will need to be "pressured" to lend more to companies and medium and small scale enterprises in this environment. On the lines of the US' Troubled Asset Relief Programme, Subbarao suggested that the Centre should consider providing capital support to financial and non-financial institutions. He also made the broader point that there needs to be a calibrated exit from any stimulus, as markets and economies tend to get used to such extraordinary support even when things settle, leading to market issues such as the taper tantrum in 2013. Using the example of Abhimanyu from Mahabharat, who was able to break into the 'chakravyuh' but was unable to get out, he said, "exit has to be carefully planned, because mistakes are costly."

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