RBI Governor Shaktikanta Das does a Draghi, walks the talk

The Reserve Bank of India (RBI) Governor Shaktikanta Das’s gameplan to revive the economy while keeping the financial markets safe and happy is a mood-lifter. With a set of simple, yet innovative, measures, Das is nudging banks to go out and lend, and ensuring the cost of money remains affordable. All without touching the repo rate. The Governor deserves full marks for looking through what he called a transient phase of high retail inflation—running now at 6.5-7%—and appreciating that much of it is the result of supply-side bottlenecks and cannot possibly be caused by demand in a contracting economy.

Das has realised that unless the economy comes back to life, and quickly, the stress on the financial sector will become unmanageable; already the moratorium and the one-time loan restructuring will take a big toll on lenders and could result in loan losses of anywhere between Rs 4-5 lakh crore. He knows it is now critical to make credit available to both the small borrower as also the not-so-highly-rated borrower and throw them a lifeline, else many thousands of units will close down. So, by raising the exposure threshold for small borrowers (with a Rs 50 crore turnover) to Rs 7.5 crore from Rs 5 crore, the central bank has given bankers additional room to lend to MSMEs. Also, at a time when demand has been destroyed, Governor Das has incentivised banks to give more home loans by tweaking the rules.

Since the government is reluctant to borrow much more on its balance sheet to provide any direct consumer stimulus and has taken on little corporate risk—Rs 3.5 lakh crore by way of credit guarantees—the central bank is stepping in to boost demand. A Rs 1-lakh-crore TLTRO—on tap—has been opened up for use by banks, not just to invest in corporate bonds or CPs but also to lend to some specific sectors. That gives banks—and borrowers—some flexibility. It is possible banks will remain risk-averse and stay with top quality borrowers as most have been doing; the response to TLTRO 2.0 was poor with Rs 12,500 crore of the available Rs 50,000 crore being used. But, by offering banks cheap money, RBI has made it easier for mid-tier businesses to access funds. Banks can also repay earlier LTRO borrowings ahead of schedule, which would free up funds.

The fact is that while there is a faster-than-expected recovery, much of it is being driven by the formal sector; the damage in the informal sector, which has been more badly hurt, can’t be undone so easily. Also, while the agricultural sector should do well, the rural economy as a whole will take much longer to recover.

Again, while consumption demand seems to be seeing an uptick, it is not clear how much of this is pent-up demand and how much of the festive fervour will sustain post-December. The economy was expected to add around Rs 180 lakh crore of GDP this year—given it is expected to contract 10%—the pick-up in sales of consumer durables, use of electricity and so on is all part of that. A 10% contraction can have serious implications on the financial system, and Das is nudging banks to lend more—currently at levels of 6-7% year-on-year, without putting them in jeopardy.

RBI’s biggest challenge this year is to manage yields given the Centre will borrow a gross of Rs 12 lakh crore, and the states too will borrow close to Rs 10 lakh crore, a 60% jump over FY20. Das’s bold decision to conduct open market operations (OMOs) in state development loans (SDL) as a special case for this year has already had an impact; corporate bond yields fell by 15-20 basis points on Friday, and the spreads for SDLs—over the benchmark—should also fall. What’s more, yields will be reined in, thanks to an increase in the quantum of special and outright OMOs to the tune of Rs 20,000 crore per auction. To be sure, no OMO calendar for the year has been announced, but Das will keep his word when he says he will do “whatever it takes”.

Indeed, Das has been more accommodative than expected given inflationary pressures are far from being tamed. With enterprises in the informal sector badly impacted, some part of merchandise sales—staples and other goods—would have moved to the formal sector where prices are higher. Hopefully, these units will survive, and demand will move back to the informal sector at lower prices; else, inflationary pressures may not subside meaningfully. But, the way out of this is to revisit the inflation-targeting mechanism with more liberal targets to help RBI stay accommodative for as long as it needs to. That is necessary given how badly bruised the economy is today. Also, petulant bond investors need to behave more responsibly, and as Das has said, they must cooperate to rein in yields. Interest rates need to remain low, and if inflation targets need to be re-set, so be it. In the meanwhile, RBI’s push for growth should be applauded.