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How the RBI is handling ‘The Great Lockdown’?

Topics Covered: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

How the RBI is handling ‘The Great Lockdown’?

What to study?

For Prelims: Key measures announced and related key terms.

For Mains: Need for and significance of these measures, implications?

Context: The International Monetary Fund has christened the ongoing economic crisis due to Covid-19 as “The Great Lockdown” and reckons it to be the worst recession that the world would have faced since the Great Depression that happened in the first half of the 20th Century.

The total estimated loss to global economic growth is pegged at $9 trillion — more than three times India’s GDP.

How is India tackling the situation? What will be its impact?

Thanks to various measures by RBI and the government, while the rest of the world is certain to contract, India is hoping to be one of the few countries that expand their overall GDP, regardless of how small that increase may be.

RBI has so far made two rounds of policy announcements to counter the debilitating effects of the spread of Covid-19 on the Indian economy.

In the first round, the RBI mainly:

  • Cut the repo rate and the reverse repo rate.
  • Started Targeted Long Term Repo Operations (TLTROs).

In essence, through these measures in the first round, the RBI:

  • Tried to provide regulatory forbearance (that is, greater leniency) in recognising non-performing assets.
  • Tried to boost the liquidity in the financial system so that businesses do not starve of funds.

In the second round, the RBI has:

  1. Cut the reverse repo rate further by 25 basis points (100 basis points make up one full percentage point). The reverse repo rate now stands at 3.75 per cent while the repo rate is 4.40 per cent.
  2. Announced another TLTRO of Rs 50,000 crore but this time it has mandated that 50 per cent of this amount borrowed by the banks must go to small and mid-sized Non-Banking Financial Companies (NBFCs) and Micro Finance Institutions (MFIs).
  3. All India financial institutions (AIFIs) such as the National Bank for Agriculture and Rural Development (NABARD), the Small Industries Development Bank of India (SIDBI) and the National Housing Bank (NHB), which borrow from the RBI and the market to extend credit to NBFCs and MFIs, will be provided “special refinance facilities for a total amount of Rs 50,000 crore” by the RBI.
  4. More funding to state governments — under the Ways and Means Advances (WMA) facility — as they try to spend to mitigate the economic stress.
  5. In respect of all accounts for which lending institutions decide to grant moratorium or deferment, and which were standard as on March 1, 2020, the 90-day NPA norm shall exclude the moratorium period, i.e., there would an asset classification standstill for all such accounts from March 1, 2020 to May 31, 2020
  6. To ensure that loans given to real estate projects, that are getting delayed due to the crisis, do not turn into NPAs, the RBI provided an extension of another year before they are recognised as NPAs.
  7. Allowed Scheduled Commercial Banks to reduce their Liquidity Coverage Ratio from 100 per cent to 80 per cent with immediate effect. The LCR essentially mandates the amount of cash that a bank is required to keep with itself.

Implications of these measures:

  1. Cutting reverse repo more than the repo, and thereby increase the gap between the two rates: On the one hand, the RBI is incentivising banks to borrow from it at low rates and lend it forward to businesses, yet, on the other, it is disincentivising them from coming back and parking these funds with the RBI.
  2. LTRO benefits: It provides more liquidity. More importantly, it also provides it targeted to those institutions that are most hit by the economic slowdown and, as such, most in need of funds to survive themselves and boost economic activity at the bottom of the pyramid (that is, the poorest customers).
  3. With reduced LCR, banks would have more cash to deal with.


Insta Links:

Prelims Link:

  1. What is Liquidity Coverage Ratio?
  2. What does 100 per cent LCR mean?
  3. How are NPAs classified?
  4. Classification of NBFCs?
  5. What are Ways and Means Advances (WMA)?
  6. SIDBI vs NHB?
  7. What is TLTRO?
  8. Trends in differences between repo and reverse repo?

Mains Link:

Amidst the global lockdown, while the rest of the world is certain to contract, India is hoping to be one of the few countries that expand their overall GDP, regardless of how small that increase may be. Discuss.

Sources: Indian Express.