RBI must rely on tolerance in the absence of tariff space

In its latest annual report, the Reserve Bank of India (RBI) expressed concern over the irrational exuberance of the stock markets. As the regulator charged with maintaining financial stability, RBI should keep an eye out for a possible inventory collapse. But he also hinted that this bubble was partly caused by excessive money supply. It is under its control and amounts to saying: “We fear that our actions on the monetary front create conditions of financial instability”. Shouldn’t it then refrain from creating money, rather than allowing a bubble to inflate? Of course, even in the best of circumstances, RBI’s job is to balance competing and often conflicting goals. If he has leaned towards monetary creation, it is because the pandemic and the confinements have required easy monetary conditions and a revival in demand for credit. He was practically pushing cheap money into the banks to lend. He bought government bonds and effectively financed most of the budget deficit. Its money creation over the past 18 months has inflated its balance sheet by almost 50%. Neither credit nor the economy grew even a fraction of this rate. Naturally, this huge stock of currency has found its way into assets such as houses and stocks. This has also happened globally, as central banks release unlimited liquidity.

But now there are signs that the excess money is also working the old-fashioned way. It leads to conventional inflation of goods and services, not just assets. Too much money for too little merchandise. India’s wholesale price index-based inflation hit double-digit figures in April. It is growing at this rate in almost all of the manufacturing sector, including in sub-categories such as metals, chemicals, plastics, paper and textiles. Internationally, the Bloomberg Commodities Index is up 53% in the past 12 months. Steel prices can exceed $ 1,000 per tonne and reach an all time high. Copper prices have already hit a lifetime record. Some of the inflation in exchange traded commodities could reflect speculative interest, as liquidity is overabundant. But underlying demand is also strong, fueled by vaccine optimism. Even the index of the Food and Agriculture Organization of the United Nations is at its highest in seven years. The prices of edible oils have doubled in a year and the prices of sugar have increased by 60%. Much of the rise in industrial commodity prices represents escalating input costs for producers, and will sooner or later be passed on to consumers, so inflation is also reflected in the price index. for consumption. The only one lagging behind, but just a little, is the energy group. Retail prices for gasoline and diesel increased slightly in India. In the United States, consumer price inflation in April hit 4.2%, the highest in decades. Even the eurozone is showing inflationary pressures.

The RBI’s Monetary Policy Committee meets for the first time this fiscal year against a backdrop of mounting inflationary pressures, both nationally and internationally. But unlike the West, where growth prospects are improving, India’s growth outlook is expected to be revised down to perhaps 8% this fiscal year. This is mainly due to the hard and unforeseen impact of the second wave. Last year, the economic impact of the foreclosure was partly offset by the resilience of rural demand. This year, this cushion is not available, despite the expected record harvest of cereals. The Center for Monitoring Indian Economy reported double-digit unemployment even as labor force participation rates fell to a worrying 40%. He also reported that 97% of Indians have lower incomes now than before the pandemic. Next year, the size of the Indian economy will still be smaller than it was two years ago, despite positive growth this year.

Thus, policy makers face three formidable challenges: inflation, unemployment and growing inequalities. Strong fiscal stimulus is needed to boost exports, capital investment and industrial growth.

What then can RBI do, which has reached the limits of monetary accommodation? It has committed to buying government bonds, which is equivalent to an Indian version of quantitative easing. Beyond key rate adjustments, it can increase its regulatory tolerance. First, announce a two-quarter moratorium for all small businesses below a threshold, with a clear message that the accrued interest will be borne by the borrower. Such a moratorium should not be left to the discretion of the banks, but mandated. Second, it can reduce the capital adequacy requirement for non-bank financial corporations (NBFCs), as they often reach where banks don’t. A lower requirement of, say, 10% instead of 15% of assets (banks should keep a cushion of only 9%) will free up capital and stimulate credit creation in the small and unbanked segments. Since NBFCs do not accept public deposits, such forbearance is appropriate in these times of a pandemic. Third, the RBI should consider paying interest on the cash reserves that banks give it. They need a recapitalization, and instead of the capital going through the government, it is a direct method of injecting much-needed largesse.

Finally, if the 2.0 restructuring guidelines announced on May 5 are welcome, RBI must ensure their implementation. The longer-term effects of covid on the banking sector will be felt next year. Just as India’s upward trajectory for fiscal consolidation has been adjusted to deal with larger deficits, the RBI has its work cut out for it. A clever combination of forbearance, loan restructuring, recapitalization and policy accommodation would help. All this without losing credit discipline.

Ajit Ranade is Chief Economist at Aditya Birla Group.

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Kristina McManus

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