Rakesh Mohan On Out-Of-The-Box Ideas For India Amid Covid-19 Crisis

That’s according to former Reserve Bank of India deputy governor Rakesh Mohan.

Mohan, who was deputy governor at the central bank from 2002 to 2009, currently teaches at Yale University.

Speaking to BloombergQuint, Mohan said India’s fiscal response has been surprisingly conservative in the face of one of the worst economic crises the global and local economy has faced in recent years. The global economy is seen entering a recession in 2020. The Indian economy too may see a contraction in 2020-21, some economists predict.

To support the economy through this period, the government will need to step up spending and, if needed, the central bank would need to step in to help finance the additional borrowings, Mohan said.

Watch the conversation here and read key highlights below:

‘Central Bank Can Address Liquidity Not Solvency’

India’s monetary policy response has been stronger than its fiscal response so far. The Monetary Policy Committee has cut its policy repo rate by 75 basis points to 4.4 percent, while flooding the system with liquidity. Specialised and targeted liquidity facilities have also been introduced.

Yet, many fear that banks are not passing on the relief. Lenders are parking close to Rs 7 lakh crore back with the RBI, in a sign that they remain averse to taking on any risk.

The central bank can address liquidity but not solvency, Mohan said.

Mohan said that some sort of backup from the government would have to be designed, which could be in the form of credit guarantee or a straightforward subsidy. “The details will always be complex but it is urgent that the government and the RBI together figure out the kind of fiscal assistance needed to address the fears of insolvency.”

‘Wary’ Of RBI Lending Against Corporate Bonds

Among the steps being widely recommended by analysts is a suggestion that the RBI start accepting corporate bonds as collateral at its repo window. This would allow the central bank to provide direct support to institutions such as non-bank lenders and mutual funds.

“I would be slightly wary of the RBI taking direct credit exposure to NBFCs and the corporate sector,” Mohan said. The RBI may not have the capacity to undertake the detailed risk assessment needed to undertake such exposure, he added.

Fiscal Response ‘Conservative’

Mohan said that he has been “mystified” by the lack of action by the government so far.

So far, the central government has announced a Rs 1.7 lakh crore package, which is less than 1 percent of GDP. Citing India’s past trends on fiscal deficit and general government debt, Mohan said India has expanded the fiscal deficit when the need arose in the past. “To my mind, the need is much greater today.”

According to Mohan, one of the reasons for the reluctance may be the experience of the fiscal and monetary stimulus enacted in the 2008-2010 period. The stimulus resulted in a wider current account deficit, excess demand and higher inflation, leading to the 2013 taper tantrum.

“I think that’s the wrong comparison... At that time, the economy was humming along...so the monetary and fiscal stimulus did lead to overheating,” Mohan said. The situation today is different.

Mohan said that the Fifteenth Finance Commission is “wise” in saying that the design of any fiscal stimulus is critical. However, in an economy where demand has collapse, the size of the fiscal stimulus is important too.

Flagging off a specific risk, Mohan said that the inability to act in time could lead to large defaults across the banking sector, emerging from many sectors ranging from airlines to hotels and logistics to automobiles.

Supporting Central, State And Local Governments

Weighing in on the debate over whether the RBI will need to step in to monetise the government’s increased debt on account of fiscal support provided to the economy, Mohan said in normal times he would be totally opposed to any direct monetisation of government debt.

But these are totally exceptional times, he said. “In totally exceptional times, you have to think out-of-the-box but prudently.”

So far, the RBI has been conducting open market operations and has increased the limit of ‘ways and means advances’ for the central and state government. This is a very good move, said Mohan.

He added that state governments may also need more support from the RBI. One possibility is doing open market operations in state government securities. These securities could also be included in the ‘Statutory Liquidity Ratio’ of banks. “Also as we used to do before the 2000s, the central government used to borrow on behalf of the state government and on-lend, that may become necessary.”

Local governments, too, may need some financing support, Mohan added.

How Low Can Rates Go In India?

With growth expected to remain below potential for an extended period of time, India’s Monetary Policy Committee will be under pressure to keep cutting interest rates. The policy repo rate currently stands at 4.4 percent, while the reverse repo rate, which some consider the guiding rate in an environment of surplus liquidity, is at 3.75 percent.

How much lower can interest rates go in India?

Mohan said that India needs to have reasonable rates for depositors since all of the bank liabilities come from depositors. To keep those deposits coming in, India needs at least “mildly positive real interest rates”, Mohan said. “I think that it would not be particularly useful for the MPC to keep reducing the policy interest rate.”

During the 2008-09 crisis, the reverse repo rate had been brought down to 3.25 percent. But lending rates remained as high as 8-9 percent. We are seeing the same phenomenon now, Mohan said.

The cost involved in this may not be very large, Mohan said. For instance, Rs 1 lakh crore in loans would cost the government Rs 2,000-3,000 crore depending on the interest rate subsidy, he said.