Monetary and Fiscal Policy during Covid19

It is now very clear that the economic impact of Covid19 is going to be far greater than anything that we’ve seen in the last fifty years, and far greater than the 2008 global financial crisis. People who are poor and middle-class are going to be the most hit in this situation world-wide especially in developing countries like India. There is a huge uncertainty about how to tackle this crisis and about the duration and revival of the entire episode. World-wide many people have died and the numbers are going to only increase as we witness this pandemic penetrating more and more.

India’s central bank, Reserve Bank of India, has unleashed some key measures in its monetary policy to help the general population on various aspects and with liquidity in the market. On the overall, India has really reacted well with its lockdown and with its monetary fiscal policy changes.

Measures introduced by RBI:

  • Repo rate cut by 75 bps to 4.4%
  • Reverse Repo rate cut by 90 bps to 3.75%
  • CRR reduced to 3%
  • Moratorium of 3% to Term Loans

A quick introduction of the above terms before we dive into the impact of each of the elements:

Monetary policy of a country is used to manage the interest rates and the total money in circulation in any economy. It is used to manage the increase or decrease of the flow of money and the quantity of money, and it has direct impact on metrics like inflation.  It is usually used along with fiscal policy (fiscal is a 12 month financial period) which is primarily concerned with treasury, public revenue, taxation policy and government spending.

Repo Rate is the interest rate at which RBI lends money to banks. If the Repo Rate is reduced, then it means that banks will have to pay less money to RBI on loans/borrowings. This reduction in interest rates will be passed on to the end consumers in terms of reduced interest rates on loans/borrowings or the bank can also eat up everything by using this money to pay their balance payables. Typically, most banks pass on atleast some portion of this benefit to the end consumer products.

Reverse Repo Rate is the interest rate which RBI provides to the banks for putting their cash with RBI. Usually, this interest rate is always lesser than the reverse repo rate, else banks would borrow money from RBI at low interest and deposit at high interest and earn the arbitrage. Since this interest rate is lowered, banks are expected to not have a great incentive to have keep money with RBI. This will motivate banks to take out that money from RBI and use that money in other ways to help customers and reduce interest rates on customer products.

Cash Reserve Ratio (CRR) is reduced to 3% from 4%. CRR indicates the minimum balance amount that banks should always maintain in their system. A reduction here will ensure that banks can use the additional 1% money and can push that into the economy, providing more liquidity and funds for the people in this situation. More than 1.37 lakh crore rupees is expected to be injected into the economy only through this CRR reduction of 1%.

A moratorium period of 3 months is extended to all term loans. This means that if you have a loan for X months, then automatically the loan will become now for X+3 months and you need not pay the EMI for these three months. Additionally, the benefit is this non-payment will not disturb your credit score. However, the interest for this period will be charged business as usual. This is still a very important and welcome measure for most of the population of the country in the current situation.

RBI has done what it has to and it has to be seen how these measures will come into effect. Most importantly, with so much liquidity injected into the market, we are also going to see that there will be a situation of excess liquidity, inflation and the weakening of rupee very soon. But, still in the current disastrous situation, RBI has more to worry about the common population and the availability of cash and cheaper cash immediately.

On the Fiscal policy, the deficit is going to be higher now. Like individuals, governments too take debt and run the country (house). But, there is always a limit to the debt one can take and it always comes at a cost. In India, total government borrowings have already exceeded the total household savings. With salary cuts and job losses, there will be no savings in the domestic market and therefore RBI will have less money from domestic borrowings. This will increase RBI’s dependency on foreign investments and debt markets, which are also drying up quickly now. So, there is a lot of fiscal and monetary pressure expected in the Indian market in the next six months.

But, firstly we all hope and pray for this pandemic to come to a stop. The economic issues can be dealt with slowly later. Humanity above all.

Hope this post is helpful, thank you.