The Reserve Bank of India (RBI) recently released the Monetary Policy Report for August 2020. This report is prepared by the Monetary Policy Committee (MPC), a statutory body under the RBI Act, 1934. The committee maintains price stability while also considering growth objectives. Key decisions on policy interest rate or repo rate to achieve the inflation target are decided by the MPC, chaired by the RBI Governor.
Policy Rates Remaining Unchanged
It was reported that the repo rate remains at 4%, with the reverse repo rate staying at 3.35%. Repo rate denotes the rate at which RBI lends money to commercial banks, while reverse repo rate is the rate at which the RBI borrows money from them. The policy rates have been kept unchanged due to rising retail inflation levels. Retail inflation measured by the Consumer Price Index (CPI) rose from 5.84% in March to 6.09% in June 2020. It breached the central bank’s target range of 4±2%, recommended by the committee headed by Urjit Patel in 2014.
Loan Restructuring Enabled by RBI
RBI has provided banks with the discretion to restructure loans to alleviate the escalating stress on incomes and balance sheets of large corporates, Micro, Small and Medium Enterprises (MSMEs), and individuals. Debt burdens are facing a significant increase relative to cash flow generation abilities, which may prompt financial stability risks if widespread and potentially lead to an increase in Non-Performing Assets. Eligible candidates for restructuring are those borrowers whose accounts were classified as standard and not in default for more than 30 days with any lending institution as of 1st March 2020. All other accounts will be considered for restructuring under the Prudential Framework issued by the RBI in 2019, or the relevant instructions as applicable. The loan restructuring scheme will be headed by KV Kamath, former ICICI Bank Chairman.
Provision of Liquidity Support
A special liquidity facility worth Rs.10,000 crore, split evenly between the National Bank for Agriculture and Rural Development (NABARD) and the National Housing Bank (NHB), was announced by RBI to aid small financiers and home loan companies amidst Covid-19 difficulties. Higher share of moratoriums availed by retail borrowers necessitated this liquidity support to lenders.
Growth Projection Outlook
Despite initial signs of economic recovery post the April-May 2020 lows, new Covid-19 infections have imposed renewed lockdowns in several regions. Consequently, economic indicators have leveled off. However, a robust recovery in the rural economy is expected due to progress in kharif sowing. Manufacturing firms are optimistic about domestic demand gradually recovering from Q2 2020-21. As a whole, GDP growth for 2020-21 is projected to be negative, but early containment of the pandemic may result in an improved outlook.
Understanding the Link between Growth, Inflation, and Interest Rates
In a fast-growing economy, rising incomes and increased purchasing power can potentially drive up prices, leading to inflation. Central banks typically contain inflation by increasing interest rates, thereby encouraging saving over spending. However, during periods of contracting growth, people’s income tends to decrease, leading to lower demand. In response, central banks usually decrease interest rates to stimulate spending and boost economic activity. The current Monetary Policy report reflects such a situation, where falling growth and rising inflation coexist, resulting from the pandemic-induced disruption to both supply and demand.
