RBI’s job involves trade-offs, not conflicts

ECONOMY/ GOVERNANCE

Topic: General Studies 2 & 3:

• Government policies and interventions for development in various sectors 
• Indian Economy and challenges with regard to resource mobilization

RBI’s job involves trade-offs, not conflicts

Context: The economic crisis caused by COVID-19 pandemic has brought to the fore the role of Central Banks. This is to avoid the repeat of history where central bankers of the 1920s failed to fight the Great Depression.

The job of Central Bank involves complex trade-offs — 

• Next quarter(Short term) vs quarter century (Long term)
• Growth vs stability
• Mandates (accountability) vs Expectations (autonomy)

Some of the measures taken by Central Banks to tide over COVID crisis are:

• Buying corporate bonds to improve liquidity in system 
• Making corporate loans to boost economic cycle
• Cutting interest rates to spur investments
• Conducting open market operations to keep rates low & adequate liquidity
• Reducing reserve ratios to avoid banks parking their funds with Central Banks 
• Additionally, banks have been permitted to 
  • Grant loan moratoriums 
  • Hold less capital
  • Restructure loans
  • Pay lower deposit insurance premiums 
  • Delay bad loan recognition
• Majority of these measures have been undertaken by RBI also – Part I and Part II

RBI’s COVID measures is constrained by pre-existing conditions in Indian banking, some of which are as follows:

• Bad loans (peaked at Rs 14 lakh crore but still large)
• Inadequate competition (scheduled commercial bank numbers have remained between 90 and 100 since 1947)
• Private bank governance (CEO so powerful that boards and shareholders are weak)
• Public sector bank governance (shareholder so powerful that boards and CEOs are weak)

Way Ahead for RBI

1. Acting cautiously to balance the next quarter and quarter century

• It must ensure that debt levels are not very high which imposes burden on future generations
• RBI cannot mimic the model of developed countries as India’s position is different. For ex: US fiscal deficit is expected to be around 15 per cent of GDP and Japan’s public debt levels is nearly 240 per cent of GDP. 
• An analogy here will be “We are all in the same storm but we are all not in the same boat”

2. Acting flexibly to blunt this economic crisis

• RBI’s mandate of Inflation targeting needs to be relooked in the light of economic disruption caused by COVID-19 pandemic
• Other flexibility options include repayment moratoriums and bank windows for NBFC/Mutual Fund liquidity. 

3. Acting within its mandate to ensure institutional legitimacy and immunity

• RBI must build on its track record of wisely balancing the trade-offs between depositors vs borrowers, companies vs banks, and stability vs growth. 
• RBI must continue to stay out of excessive government interference.

Conclusion

Creating a prosperous India needs many things. One of them is an independent, accountable, and boundaried central bank that listens.

Connecting the dots:

• Keynesian Economics
• 2008 Financial crisis and measures taken to come out of the crisis