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

A one-time monetisation of the government’s debt, financing support for state governments, loan guarantees for small businesses and interest rate subventions for corporations may be some of the exceptional measures that India may need to consider as it designs a policy response to deal with the economic fallout of Covid-19.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..If banks in their risk assessment have significant fear of insolvency, whether for mortgage borrowers, retail borrowers or small and large industries, they are likely to be risk averse. Therefore, I think the principle here is that it is only the fisc that can bear the risks arising from fears of insolvency.Rakesh Mohan, Former RBI Deputy Governor.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 BondsAmong 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..What RBI can do if necessary is to funnel liquidity to the corporate sector or NBFCs by setting up a special purpose vehicle. But once again, the SPV would need to be backed by the fisc in case of solvency-related losses. We need to be clear what the issue is. If the issue is fears of insolvency, then the fisc has to be in action. If it is pure liquidity, then it’s in the ambit of the RBI. Rakesh Mohan, Former RBI Deputy Governor.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..The economy was already underperforming even before the lockdown. There is a likelihood of the economy actually going into recession... Therefore, there is no chance of excess demand at present. So, it seems to me that it is extremely important to enact fiscal measures now, partly so that we don’t have to do even larger fiscal measures later... We are being far too conservative in expanding the fiscal deficit in the current situation.Rakesh Mohan, Former RBI Deputy Governor.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..Unless fiscal help is given to these sectors in a prioritised, organised manner, we could be looking at additional large NPAs in the system. Given the stress from which the financial sector was already suffering, we could be looking at further pain. If not addressed now, this could result in a much larger fiscal bill in the future... This will also impede the recovery as and when the lockdown ends.Rakesh Mohan, Former RBI Deputy Governor.Supporting Central, State And Local GovernmentsWeighing 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.”.I think the RBI, as debt manager to the central and state governments has a number of tools available to it. It will need to use all of them as necessary. It should also be open to the possibility of direct central bank financing of the government deficit in these circumstances. In normal times, I would be totally and utterly against that.Rakesh Mohan, Former RBI Deputy Governor.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..I have an out-of-the-box suggestion. What is it you want? You want borrowers, small medium and large, to get the benefit of lower interest rates, that would also reduce the risk aversion of the banks. At the same time, you would keep rates at a level that is in the interest of depositors. An easy solution is that the government should offer a 2-3 percent interest rate subsidy across the board for a fixed limited period of time like 3-6 or even 12 months. Rakesh Mohan, Former RBI Deputy Governor.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.

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

Former RBI deputy governor Rakesh Mohan details some exceptional measures India may need to consider amid the Covid-19 crisis.

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