On October 9, three important documents — resolution of the Monetary Policy Committee (MPC), the governor’s statement and the Monetary Policy Report (MPR) — were released by the RBI. Taken together, the three offer the essence of (a) stance of monetary policy, (b) macroeconomic outlook for growth and inflation for the current fiscal along with the Q1 of 2021-22, (c) a list and magnitude of liquidity measures, (d) transmission of monetary policy to revive the economy, and (e) ways to revive the economy from the blows of the pandemic.

The MPC resolution with three new external members was released on the eve of the 25th meeting under the monetary policy framework adopted since June 2016. There was a unanimous decision to hold the policy repo rate constant primarily because the headline inflation measured in terms of Consumer Price Index Combined (CPC-C) has been continuously above the targeted ceiling level of 6 per cent since January 2020. However, to the extent revival of growth on a durable basis is the priority, the MPC decided to “continue with the accommodative stance of the monetary policy as long as necessary — at least during the current financial year and into the next year” with a divided casting vote of 5:1.

It is important to mention in this context that the RBI has been extremely pro-active in its liquidity support to the financial system. According to the MPR October 2020, overall, total liquidity support announced by the RBI since February 6 (up to September 30, 2020) amounted to ₹11.1 lakh crore (5.5 per cent of GDP) in terms of various monetary policy instruments. This is huge firepower by any standards.

So, it is interesting that the MPR notes that central banks (across the globe) have gone “where they have feared to tread before”. As the MPR put it: “They have undertaken what even until recently they considered as the commission of original sins — the monetisation of fiscal deficits…”

If so, then it might be said that the RBI leads in the commission of this “original sin” because the ₹11.1 lakh crore of liquidity provided by it could otherwise be seen as monetisation of the fiscal deficit.

The “original sin” by the RBI is further corroborated by the investment of commercial banks in government securities, which has been 2.24 times higher during the period April 1 to September 25, 2020 (₹6,98,813 crore) than the corresponding period of the previous year. Furthermore, the above investment accounted for 62.4 per cent of the total market borrowings (both Central and State governments) of ₹11,19,596 crore as compared with 46.7 per cent of the total market borrowings funded by the investment from the banks.

Printing money

Such funding of market borrowings of the government has been facilitated by liquidity support from the RBI, which in ordinary parlance means printing money. To the extent the banks heavily funded the borrowing programme of the government, it has facilitated by keeping the government bond rates lower (the weighted average cost of borrowings by the Central government during the first half of 2020-21 at 5.82 per cent is the lowest in the last 16 years) as mentioned in the governor’s statement. This development, thus, begs the question whether the monetary authority should also function as the debt manager of the government.

Another aspect in the context of the “original sin” is the transmission mechanism of monetary policy and credit offtake. According to MPR October 2020, the cumulative reduction in policy repo rate from February 2019 to September 2020 was to the tune of 250 basis points but reduction in weighted average lending rate was 162 basis points.

However, with the injection of liquidity coupled with external benchmark rates in place of MCLR (marginal cost of funds based lending rate), transmission has been somewhat encouraging with a 91 basis points reduction during March 2020 and September 2020 as against a policy repo rate reduction of 115 bps.

As per the available data, during 2020-21, non-food credit on an incremental basis recorded a higher contraction of ₹1,13,666 crore on a financial year basis (up to September 25) than that of a contraction of ₹21,344 crore in the corresponding period of the previous year. This shows even though the transmission has improved, credit offtake has remained “feeble”. This also questions the efficacy of monetary policy stimulus through interest rate reduction to boost private investment. The standard and popular prescription — reduce rates to boost growth — is just not working.

After a long haul, the outlook on growth has been released by the RBI in the MPC resolution.

Two important projections, (a) the real GDP growth for 2020-21 is expected to be negative at (-) 9.5 per cent and (b) for Q1 of 2021-22, the MPC has estimated the growth rate of 20.6 per cent.

Furthermore, the MPC resolution has projected CPI inflation at 6.8 per cent for Q2:2020-21, at 5.4-4.5 per cent for H2:2020-21 and 4.3 per cent for Q1:2021-22, with risks broadly balanced. The growth and inflation outlook set out in the MPC resolution when seen in conjunction with the assumptions in the MPR reveal very interesting observations.

Uncertain factors

The RBI is comfortable with the estimates of highly volatile and uncertain factors like crude oil ($40.9 a barrel), exchange rate (₹73.6 for a dollar), monsoon (9 per cent higher than long run average), global growth (-4.9 per cent in 2020 and 5.4 cent in 2021) and macroeconomic/structural policies (no major changes).

All this is fine. But, as the debt manger and fiscal agent, the RBI shies away from providing estimates for the fiscal deficit — it very vaguely states that “fiscal deficit is expected to be significantly higher”.

In the context of growth revival, though the RBI has not taken any stance on the recovery to be V (quick recovery), U (delayed recovery), L (longer delayed recovery), W (quick recovery but again contraction) or K (recovery with increased inequality), the estimate of a 20.6 per cent real GDP growth rate implicitly makes a case for a V-shaped recovery.

Three-speed approach

The governor, however, set out a three-speed approach to recovery and dipped into cricket to offer the view that sector-specific realities will come into play: a) agriculture, FMCG, two-wheelers, passenger vehicles, pharmaceuticals, tractors, etc., will “open their accounts earliest”, (b) some other sectors will show slower normalisation and will “strike form” gradually, and (c) the sectors which will be in the “slog overs”, which are essentially contact–intensive and most severely affected by social distancing.

The governor has called himself an optimist, and observed in this context that “a faster and stronger rebound is eminently feasible”. Notwithstanding this claim, the MPR has mentioned that near-term outlook remains hostage to virus and attendant uncertainties around the discovery of a vaccine to stop the spread of the Sars-Cov-2 virus. To the extent the virulence of the pandemic is yet to abate and a solution is critically dependent on a vaccine, all endeavours should be shifted to the health sector, both by public and private participation rather than the RBI engaging in the commission of the original sin.

The writer is a former central banker and a faculty member at SPJIMR. Through The Billion Press