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Current Affairs

RBI’s handling of ‘The Great Lockdown’

Date: 18 April 2020 Tags: Monetary Policy & RBI

Issue

Reserve Bank of India Governor Shaktikanta Das unveiled the second round of policy announcements to counter the debilitating effects of the spread of Covid-19 on the Indian economy.

 

Background

The International Monetary Fund has christened the ongoing economic crisis due to Covid-19 as “The Great Lockdown” and reckons it to be the worst recession that the world would have faced since the Great Depression that happened in the first half of the 20th Century.

 

Details

  • While the rest of the world is certain to contract, India is hoping to be one of the few countries that expand their overall GDP, regardless of how small that increase may be.

  • The RBI had announced a flurry of measures essentially trying to do two things: One, provide regulatory forbearance (that is, greater leniency) in recognising non-performing assets; Two, it tried to boost the liquidity in the financial system so that businesses do not starve of funds. 

  • To achieve the latter, it cut the repo rate (the rate at which it lends money to the banking system) and the reverse repo rate (the interest rate it pays banks when they park their money with the RBI).

  • It also started Targeted Long Term Repo Operations (TLTROs) — essentially, this facility allowed banks to borrow money from the RBI at the repo rate, which is far lower than the prevailing interest rate in the market.

  • The hope was that banks would use cheaper loans to extend cheaper credit to businesses and that will help businesses survive this tumultuous period.

  • The RBI has cut the reverse repo rate further by 25 basis points (100 basis points make up one full percentage point). The reverse repo rate now stands at 3.75 per cent while the repo rate is 4.40 per cent.

  • The idea behind repeatedly cutting reverse repo more than the repo is two-fold: On the one hand, the RBI is incentivising banks to borrow from it at low rates and lend it forward to businesses, yet, on the other, it is disincentivising them from coming back and parking these funds with the RBI.

  • The second key thing that the RBI has done is to announce another TLTRO of Rs 50,000 crore but this time it has mandated that 50 per cent of this amount borrowed by the banks must go to small and mid-sized Non-Banking Financial Companies (NBFCs) and Micro Finance Institutions (MFIs).

  • The benefits of this move are two-fold. One, it provides more liquidity. But more importantly, it also provides targeted boost to those institutions that are most hit by the economic slowdown and, as such, most in need of funds to survive themselves and boost economic activity at the bottom of the pyramid (that is, the poorest customers).

  • The RBI has allowed Scheduled Commercial Banks to reduce their Liquidity Coverage Ratio from 100 per cent to 80 per cent with immediate effect. With this being reduced to 80 per cent, banks would have more cash to deal with.