RBI must support government spending to kick-start growth

The Reserve Bank of India
The central bank needs to focus on transmission, reducing spreads and increasing credit delivery.

By Ashima Goyal

The divergence between CPI and WPI inflation has appeared once again with the former in the RBI target band and the latter in negative range. In 2010, this was responsible for the industrial slowdown, as RBI targeted the higher CPI, but WPI was low and more relevant for the industry.

Today, however, with the short-term rates below the reverse repo rate and inflation figures unreliable, there are inherent uncertainties due to the spread of Covid-19 and arbitrary state lockdowns that are disrupting supply chains. It is important to continue anchoring inflation expectations, so a pause is called for at present. But the temporary supply bottlenecks are expected to be resolved, and the headline will converge to a core that will be soft due to a collapse in demand. The RBI should clearly signal this, and that it continues on the accommodative path and has space for future cuts.

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Meanwhile, the central bank needs to focus on transmission, on reducing spreads and increasing credit delivery. Recovery needs a counter-cyclical rise in credit growth. Liquidity should be kept in surplus since that is helping transmission, but the degree of surplus can be reduced since that also creates risk. Banks have been given carrots and now need some competition.

Reverse repo rate can be lowered by 10 bps to make it more attractive to banks to lend. Corporate repos can help bond markets recover and increase market confidence, at a time when risk aversion is high. Counter-cyclical macro and micro prudential regulations can also induce more lending as well as increase financial stability. Ways should be found to enable term loans for smaller NBFCs.

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Since India has limited policy space its use has to be sequenced so it is most effective. Since household precautionary saving is rising in these uncertain times, the government spending has to kick-start growth. The RBI has to enable frontloading this by signalling OMO support. Some kind of capital flow management may be required to restrain the large expected surge in liquidity from capital inflows when the current account is in surplus.

(Ashima Goyal is professor, IGIDR and member, PMEAC. This article is a reproduction of her views expressed at the shadow Monetary Policy Committee meeting organised by EGROW Foundation, a Noida-based think tank. Views are personal.)

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