Mumbai: India’s central bank and government will need to raid their policy toolkits to respond to a myriad of global and domestic risks threatening an economy in the grip of a prolonged slowdown.
On top of the coronavirus outbreak and the oil-price crash, India was rocked last week by the biggest bank rescue in its history. With the rupee now close to hitting a record low, policy makers will need to step up monetary and fiscal support to restore investor confidence.
The Reserve Bank of India announced a $2 billion injection for the foreign exchange market Thursday. Officials say Prime Minister Narendra Modi’s administration is exploring options from federal government spending to RBI liquidity measures to boost the economy. Analysts are also betting on an emergency interest-rate cut and government stimulus.
“The task before policy makers is to maintain financial stability and ensure growth doesn’t slow down sharply from a weak starting point,” said Prasanna Ananthasubramanian, chief economist at ICICI Securities Ltd. in Mumbai.
The failure of Yes Bank Ltd., the nation’s fourth-biggest private lender, and a decision to write down some of its bonds, will further curb credit in an economy already suffering a cash crunch because of a shadow-banking crisis. That’s pulled down economic growth to an estimated 5% in the fiscal year through March, the weakest in more than a decade.
The volatility in oil adds a new layer of risk just as the economy was showing nascent signs of a rebound. While lower prices will benefit India since it’s a major importer of crude, global demand will take a knock, weighing on export and investment growth.
The credit crunch and oil-price collapse open the door to bigger interest rate cuts than initially projected.
After lowering rates five times in 2019 by a total of 135 basis points, the central bank went into pause mode in December following a spike in inflation to well above the central bank’s 2%-6% target.
The sharp slide in oil prices now will curb inflation and give the RBI space to ease once again. Even before the Yes Bank crisis, Governor Shaktikanta Das had signaled his willingness to do more to support the economy if needed as the coronavirus threatened growth.
ICICI Securities’ Prasanna sees the possibility of 65 basis points of rate cuts in coming weeks — 25 basis points possibly at an emergency meeting and 40 basis points at its next scheduled rate decision on April 3.
“The worry is how interlinked Yes Bank is with other financial institutions,” said Shumita Deveshwar, director of India research at TS Lombard. “The uncertainties and headwinds to India’s growth revival are building up, and the authorities will have no choice but to react with easier monetary policy.”
In recent months, the central bank has resorted to unconventional measures to pull down borrowing costs. It’s used a mix of the Federal Reserve-style ‘Operation Twist’ and the European Central Bank-like long term repo operations, or LTROs, to bring down term spreads and enable better transmission of rate cuts.
“We think the RBI may extend the recent LTRO program after its initial success, which could see the bank sector relying more on wholesale funding compared with deposits in the near term,” said Rahul Bajoria, a senior economist at Barclays Plc in Mumbai.
Other possible options:
- Open market operations: HSBC Holdings Plc estimates the RBI bought 3 trillion rupees ($40.6 billion) of bonds in the market in the year through March 31 last year, making up more than 70% of sovereign bond issuance
- Funding for Lending Scheme. The Bank of England carried out this program in the aftermath of the global financial crisis, accepting eligible collateral from banks and building societies at a discount and swapping it for nine-month Treasury bills that could be rolled over for up to four years. The operation lowered funding costs and increased net lending to the non-financial sector
The government is under pressure to inject more funds into weak banks, especially state-run ones — which are already under stress because of India’s struggling power and telecommunication sectors.
It pumped nearly 1.7 trillion rupees into public sector banks in the two years to March 2020. But a widening budget deficit and weak revenue growth put a brake on any further recapitalization plans in the coming financial year.
Lower oil prices may be a windfall for the government. Kotak Institutional Equities estimates a $10 decline in crude adds $1.9 billion to India’s budget as fuel subsidies fall, while the state could generate $8.5 billion in potential revenue from higher energy taxes.
If the Yes Bank’s resolution process is prolonged, there is a risk banking activity will take a hit. The RBI’s move to permanently write down Yes Bank’s 87.8 billion rupees of additional tier 1 bonds — hybrid securities — threatens to hurt capital raising and imperil loan growth and economic activity.
The rescue plan entails State Bank of India buying a 49% stake in Yes Bank. The RBI could also be looking at extending a loan of $1.4 billion to Yes Bank to meet its immediate liquidity needs, according to the Mint newspaper.
“Policy makers need to go back into proactive mode rather than the reactive mode they seem to have slipped into,” said TS Lombard’s Deveshwar. “Authorities need to clean up the financial sector rather than trying to soften the blow and prolong the pain.”-Bloomberg