Liquidity Changes by RBI Monetary Policy Committee

Varun Hariharan

23 Nov, 2020

Money markets around the world have been hearing the term COVID-19. Not just global money markets are affected by the scenario, but the overall financial conditions are bleak. The primary focus at the beginning of the quarter was on the Covid-19 pandemic. The effect of Covid-19 has disrupted the global economic scenario. Money markets around the world have closed due to the situation. Globally every central bank has implemented a monetary policy to save the country from a liquidity crisis. Certain adjustments were brought out on the monetary policies of countries to support economies in uncertain times. The question put forth to every central bank, is how effective will the monetary policy be? Apart from having a strong monetary policy to save the economy, the country would also require a vigilant fiscal stimulus to deal with the situation.

A similar crisis scenario is also present in India. The impact of Covid-19 has made authorities to bring out stringent measures to handle the crisis. Some of the authorities are SEBI, MCA, and RBI. The RBI Monetary Policy Committee brings out measures to address the liquidity crisis in the country. In the 2008 economic crisis, the RBI Monetary Policy brought out various measures to relax the damages caused to the economy. 

Measures taken by the RBI Monetary Policy Committee during Covid-19 Pandemic

The Reserve Bank of India (RBI) made several changes to address the fiscal crisis in the country. One such change was the revision of the repo rate. Repo rate is understood as the rate at which the Central Bank of the country (RBI) lends money to commercial banks for consumption. Normally, in a crisis scenario the RBI has the authority to either increase or reduce the Repo rate. The rate at which banks borrow money by selling specific securities to the RBI is known as the repo rate.

Reverse Repo rate is the rate at which RBI borrows money from commercial banks. Therefore repo rate can be understood as the rate at which commercial banks borrow from the RBI and reverse repo is known as the rate at which the RBI borrows money from commercial banks.

In March 2020, the Governor the RBI Mr. Shaktikanta Das announced to certain changes in consultation with the RBI Monetary Policy Committee to handle the crisis scenario in the country. One of the main changes considered in this press release was the adjustment of the repo rate to 4.40%. Before this the repo rate was set to 5.15%. A reduction of 75 basis points was required on the repo rate of the country.

Apart from the reduction of the repo rate, the following changes were considered by the RBI monetary Policy Committee:

• Reduction of the repo rate from 5.15% to 4.40% under the liquidity adjustment facility
• Reduction of the Reverse Repo rate from 4.90% to 4%
• Reduction of the marginal standing facility from 5.40 % to 4.65%
• Cash Reserve Ratio has been reduced by 100 basis points to 3%
• The monetary policy committee considered these changes are required to address the liquidity crisis in the country.
• For working capital facilities purposes, banks and other lending institutions are allowed to defer three months on the payment of interest on loans. The interest that is accumulated over the loan will be paid after the moratorium period.
• The RBI monetary policy committee also required lending institutions and banks to work on reassess the position of borrowers.

Why were the changes brought by the RBI Monetary Policy Committee in March 2020?

• The global economy has been affected by the COVID-19 outbreak. India has already undergone a similar situation during the 2008 economic crisis.
• All countries around the world have increased measures to follow lockdown regulations and social distancing norms.
• Covid-19 has a devastating impact on all economies around the world. This has affected money markets and brought liquidity crisis.
• Markets are facing instability around the world due to the current situation
• Supply chains across the globe have changed due to the closure of business. This is a problem for various BRICS (Brazil, Russia, India, China, and South Africa) nations as they are emerging economies in the world.  Emerging economies depend on the western world for securing investment and resources.
• As a consequence of this scenario, Central Banks around the world have taken strict measures towards their monetary policy of the country to control the economy.
• On a national front all sectors of the economy have been affected. Right from the tourism to the manufacturing sector has taken a major blow.

Changes considered by the RBI Monetary Policy in May 2020

The Government of India brought out the first national lockdown across the country on 24 March 2020. The lockdown period was for 21 days. On April 14 another lockdown was brought by the union government (Lockdown 2.0) which was extended until May 03.

On may 03 the Union Government with of view of relaxing certain economic activities decided to have specific relaxations in certain sectors? Out of all the sectors which were allowed relaxations, the government stressed the requirements for the banking, finance and insurance sector to partially open. Various authorities such as the RBI, SEBI, and MCA were given the green signal to bring out certain recommendations related to the Monetary Policy and the current economic scenario.

Given this, to control the liquidity crisis the RBI along with the Monetary Policy Committee has brought out recommendations to control the macro-economic crisis.

Recent Analysis carried out by the RBI Monetary Policy Committee

Based on a global assessment carried out by the RBI monetary policy committee, the following considerations were established:

• In March 2020, the RBI Monetary policy had a review of the economic condition in India. However, the global activity has not improved since then. The business activities of advance economies such as the USA and UK have depressed ever since the spread of COVID-19
• All emerging markets such as BRICS went into a recessive phase.
• All markets such as the western and emerging markets have targeted to develop their monetary policies. In line with this, the central banks of these economics have developed their respective monetary policies to tackle the scenario.
• There are frequent changes in the price related to crude oil and countries producing oil wanted major changes such as cutting production, this indirectly affected the countries which were dependant on crude oil

Domestic Assessment- RBI Monetary Policy Committee

On a domestic front, the effect of the two-month lockdown has severely impacted the economy. Urban and rural economies are witnessing the impact. Manufacturing industries have also reduced production lines due to the fact of lesser consumption of electricity. Apart from this the lack of capital goods has brought about severe repercussions in the supply chain in India.

In the service sector, several industries such as travel and development of foreign tourism have depleted due to the effect of lockdown and Covid-19. Therefore high-frequency indicators such as the manufacturing and service sectors are major additions to the declining economy.

The only positive indicators are the development of agriculture activities. The production of domestic pulses has increased to 43.5%. Apart from this agricultural produce and procurement of pulses such as khadi and Rabi has improved. On a domestic front, India still seems to be a major exporter and producer of agricultural produce.

The retail sector faced challenges related to inflation. In December 2019-January 2020 inflation reduced from double digits to single digits (5.8%). Out of all the retail products, food inflation was the highest peaking at double digits in 2019. The effect of the lockdown brought about supply chain challenges in the food sector which indirectly affected inflation. In April inflation on food products increased to 8.7 % from a previous value of 7.8% in March.

To tackle this situation, the RBI monetary policy committee came up with a system to assess the risks related to the liquidity crisis. The system used by the RBI had a mix of both conventional and unconventional methods to manage the fiscal situation. In this system, the RBI came up with a systematic method of implementation of liquidity measures in sectors which faced severe liquidity crisis.

The RBI had taken the following measures to improve the situation

• RBI has increased the amount of liquidity adjusted facility to 5.66 Lakh Crore for May 2020. Previously the amount of LAF in April was estimated 4.75 lakh crore
• Apart from this the RBI Monetary Policy Committee put Rs.1, 20,474 crore in open market operations.
• The RBI Monetary Policy Committee has further injected Rupees 87,891 crore for three targeted long-term repo operation (TLTRO) auctions.
• Operation Twist is an auction that is conducted by the RBI involving the sale and purchase of government based securities for Rs 10,000 crore each. This operation twist was conducted on 27 April 2020.
• Apart from this the government has invested Rs. 22,000 crore in National Bank for Agriculture and Rural Development (NABARD), Small Industries Development Bank of India (SIDBI) and National Housing Bank (NHB)
• The RBI monetary policy committee has provided various options for refinancing.  One such option is provided to mutual funds through the mode of the special liquidity facility to ease liquidity in the markets.
• In the year 2020, the RBI has announced liquidity augmenting measures of more than Rs 9 lakh crore which adds up to nearly 4.6 % of the GDP.

These methods have eased the liquidity measures on domestic financial institutions. Domestic instruments such as commercial papers, government securities, and treasury bills have become more smooth. The credit growth of the economy has declined yet the amount of investments made by commercial banks on the above investment has increased to Rs 66757 crore. This is higher when compared to the same period last year where the amount of investment from commercial banks declined rapidly.

There has been a decline in the export and import business in India, which is reduced to 60.3% for export and 58.6% for imports. Out of 30 commodity groups in imports all declined in the amount of imports. On the other hand, out of 30 commodity groups in exports, 28 declined and the rest two commodity groups performed well. Though these effects are present, the amount of inward investment in the country has improved. The amount of Foreign Direct Investment (FDI) in India was recorded at US$ 2.9 billion which is more than the amount of foreign direct investment in the previous year. Even the Foreign Portfolio Investment sector has improved securing USD 1.2 billion.

Predictions made by the RBI Monetary Policy Committee

Though the World Health Organisation (Who) has not given a timeline for the eradication of COVID-19, still economic activity has to continue throughout the world. The RBI Monetary Policy Committee has predicted the outlook of India’s fiscal policy.

As the lockdown eases, there will no supply chain disruptions affecting the food industries. This would indirectly affect the food inflation index which would gradually decrease. Manufacturing activities have started across the country which will indirectly improve the supply of capital goods for the production of finished products.

The lockdown effect has affected agriculture in the first quarter due to which the amount of produce in the form of pulses has reduced. This area would gradually moderate after the relaxations post lockdown. Economic activity over the second quarter would not improve, due to the effect of the social distancing norms. These norms will be enforced in IT infrastructural hubs, restaurants, and other places that attract the crowd. Apart from this shortage of labor may be another issue for agricultural activities.

Changes made by the RBI Monetary Policy Committee

To infuse money into various sectors, the RBI Monetary Policy Committee brought out the following measures:

• The REPO rate has been reduced with immediate effect from 4.40% to 4.00%. The rate has been reduced by 40 bps.
• Marginal Standing Facility has been reduced from 4.65% to 4.25%
• The Reverse Repo rate has reduced to 3.25%.
• The RBI monetary policy Committee also considered maintaining this position until the economy revives after the effects of COVID-19. By considering all these changes the rate at which the RBI lends money to commercial banks and vice versa will remain stagnant until further measures are taken by the committee.

Conclusion

The effect of the COVID-19 pandemic has brought out devastating effects on the global economy. To tackle this situation the RBI monetary policy committee in March 2020 addressed certain changes in the REPO and reverse repo rate which affects banks in the country. Apart from this RBI has brought changes to the marginal standing facility which affects the fiscal scenario. Though there were changes brought, the situation affecting global markets did not take a turn. To reduce damage, the RBI has further brought changes to the monetary policy of the country.