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RIS
It is only but very rarely that a central bank announces emergency liquidity and other measures whose ‘immediate objective is to preserve human life and restore livelihoods.’ That’s what the RBI did and announced in an unscheduled press conference on May 5. The success or otherwise of these measures as also those introduced last year, with all their ramifications, will be known in the years to come. And, for sure, one will witness, for a long time to come, intense debates on the pros and cons of the obliteration of the long-recognised boundary between monetary and fiscal domains, as is happening now. But this is an extraordinary situation, never seen and faced in living memory. A gigantic humanitarian and economic crisis now stares India straight in the face, even as the total of and the daily additions to the Covid caseload are scaling new heights. If there is any question that is topmost in everyone’s mind it is ‘when will the second wave curve flatten?’ Sadly, no one has any clue. And, the experts are already talking about the imminence of an even more virulent third wave.
Major takeaways
The first and the most important takeaway is that the present accommodative stance of the monetary policy will continue indefinitely. The MPC of the RBI is not likely to cut the policy rate further in its next meeting despite the lowering of the expected GDP growth rate for 2021-22 by the IMF a few others, probably because there are concerns about a possible spike in inflation due to a fresh supply chain disruption induced by the new restrictions and containment measures.
The design of the Term Liquidity Facility of Rs. 50K crore to banks for creating a Covid loan book as a portfolio of lending support to a wide range of entities involved in the country’s fight against the pandemic is imaginative. The two incentives provided to banks in this regard will make this facility more attractive than has been the case with similar facilities announced last year.
One can debate endlessly whether vaccine production is a profitable business in the long run or not, but the fact that institutional credit has reached these two companies through money printing by the RBI doesn’t leave us with a good deal of comfort.
Close on the heels of RBI’s announcement, two leading PSU banks each made public their decisions to lend under this facility to Serum Institute and Bharat Biotech respectively. These actions are laudable. However, there is a larger issue here: why these two leading vaccine manufacturers had to wait for the RBI’s special liquidity window to raise money for funding their research and expanding their production? One can debate endlessly whether vaccine production is a profitable business in the long run or not, but the fact that institutional credit has reached these two companies through money printing by the RBI doesn’t leave us with a good deal of comfort.
The introduction of a Rs. 10K crore Special Long-Term Repo Operations (SLTRO) for Small Finance Banks (SFBs) is also a timely step, in recognition of their role at the bottom of the credit pyramid of the country.
The present surplus system liquidity condition, with daily net liquidity absorption by RBI under LAF averaging at Rs. 5.8 lakh crore in April, 2021 is likely to continue although there seems to be some renewed focus on how to utilise it for supporting growth impulses. Regardless of whether this bears any meaningful fruit in the immediate run, further addition to the kitty of surplus liquidity is possible in view of the RBI’s G-sec buying plan under G-SAP.
The second wave has created significant additional stress for individuals, small businesses and MSMEs almost across the board.
Given the possibility of the fiscal deficit of the central government exceeding 6.8% of GDP in 2021-22 and consequently its gross borrowing requirement becoming higher than the projected Rs. 12.05 lakh crore, enhancement in the G-SAP target beyond Rs. 100,000 crore seems a distinct possibility, especially because of the government’s desire that its borrowing cost should not be allowed to go higher. The growth rate of the reserve money during 2020-21 moderately exceeded its long-term average, which trend is likely to continue in 2021-22, suggesting that the RBI’s liquidity policies and operations have so far been well-strategized and well-delivered.
Resolution Framework 2.0
The second wave has created significant additional stress for individuals, small businesses and MSMEs almost across the board. The resolution framework 2.0 has been designed to address this issue and also to alleviate, to some extent, the resulting adverse impact on the financial sector. No wonder, this has been widely welcomed and supported. However, it may not be out of place to take a deeper look at the efficacy of the extant framework and approach for restructuring/resolution of stressed bank debt, especially with respect to MSME borrowers. A starting point for this purpose could very well be the fact that restructuring has not worked so far in this country. In most cases, it results in evergreening and/or good money chasing bad money together with all the attendant inefficiency in the use of the lendable resources of banks.
A much better and effective proposition for enhancing MSME growth in India will be to promote the setting up of 7-10 large Alternative Investment Funds (AIF) in which each large scheduled bank will put money as a defined proportion of its MSME portfolio.
The reasons are too well known to be recounted here. In the present context, the core issue in the case of any stressed MSME is that its net worth is either very low or negative. Hence, they cannot be revived without the infusion of fresh equity. The government seems to have realised this need, leading to its announcement of the CGSSD scheme last year whereby it would provide guarantees to bank loans to the promoters of MSMEs to invest in the equity/quasi equity of their respective companies. The aggregate amount of equity/quasi equity fusion has been tagged at Rs.20K crore. Though a well-meaning initiative, it is unlikely to go too far in solving the problem on hand. At the core of it lies the fact that lending to MSMEs in India is a high-risk business, whose return seldom provides adequate compensation. Lending to promoters under CGSSD will also involve a very high risk, which banks are not well-equipped to assess or evaluate.
In general, if the fisc wants to provide an efficient backstop for risk-taking, the first order of business should be that risk decisions are taken well. A much better and effective proposition for enhancing MSME growth in India will be to promote the setting up of 7-10 large Alternative Investment Funds (AIF) in which each large scheduled bank will put money as a defined proportion of its MSME portfolio. The government should also put money by way of budgetary allocations in them. These AIFs, which will be professionally managed with governance and performance standards mirroring the best global benchmarks will invest in the equities and also, in exceptional cases, in the debt of MSME companies. Fortunately, the country now has a critical mass of professional talent required for this purpose. This could very well be yet another reform to be undertaken in the wake of the crisis caused by the pandemic.
(The writer is a former central banker and consultant to the IMF)