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Recalling the economic concepts in wake of COVID-19 in India

Writer's picture: Jaspal KahlonJaspal Kahlon

Monetary policy has been my area of interest since my doctoral days. I did an exhaustive literature review on the impact of monetary policy changes on the economy. Though I never submitted my thesis, the topic remains my area of interest.


My primary hypothesis remains that the effect of changes to interest rates do not influence the financial health of the companies and individuals. Take, for instance, a borrower who has a home loan, and the monthly EMI that he pays is changed by a few hundred or a couple of thousands. For a debt that is of long-term in nature, any cyclical shift in monetary policy stance is not significant. A borrower is only benefitted when the structural changes are made, e.g., the tax break limit on home loans in increased.


My understanding of monetary policy is misplaced since the most crucial goal of monetary policy is stable interest rates. Stability adds predictability to the future cash flows generated from investments made by the companies.


RBI has the power to print money and control the amount of money in circulation in the economy. The banks and their variants like Non-Banking Financial Companies (NBFCs) are governed by the RBI and are required to adhere to the rules defined to conduct their business of lending and raising deposits.


RBI is the last and the most trusted source for banks to meet their short-term funds requirement, which could be for a day, a week, and in some cases for longer duration as well. RBI, however, does not lend with having risk free securities as collateral from the bank. Such type of lending is called a Secured loan. The interest payable to RBI is decided by RBI and is called repo rate. There is a counterpart of repo rate called reverse repo that is when RBI takes excess funds of banks as deposit and pays them an interest in return.


Repo and reverse repo rates are the base rates in the economy. Theoretically speaking, they should be the lowest in the marketplace and are 100% risk-free until the RBI, and the Government goes bankrupt, a remote possibility for India in present circumstances.


So there is no risk premium added to repo rates. When banks decide their interest rates, they add their own cost of doing business, risk of default, and rates determined by other banks. The banks also take into consideration the cost at which they have to pay on deposits, including savings rate. All the components of the bank’s business are closely linked with high inter-dependability.


Banks consider the loans they lend as their assets and deposits as their liabilities, precisely opposite to us. On a different note, I intend to avoid bank loans, especially the long-term ones, reasoning they are simply meant to make banks profitable.


I believe that lowering repo rates on March 27, 2020, and further reducing the reverse repo rates, at a later date, may not help the last borrowers in the chain. The initiatives, at best, would help banks tide over the tough times on their books as a result of rising NPAs.


The excess liquidity works only when the banking sector is financially healthy, and there is a rise in consumer demand. All the economic factors are so closely linked in a continuum that it is difficult to know where to intervene. So in the present context, presuming that the lockdown does not extend beyond May 31, 2020, the monetary policy measures are simply a breather for banks alone.


The government is yet to announce any significant tax breaks for individuals and corporates that ensure the protection of jobs. Looking forward to measures that are in line Paycheck Protection Program of the US.

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