India’s central bank has reduced interest rates a number of times to kick-start the pandemic-hit economy, but a senior economist said the plan is “simply not working.” Rathin Roy, the director of National Institute of Public Finance, a government research institution, said the rate cuts have been unsuccessful because banks have been reluctant to pass the benefits on to their customers.
At an Annual Economics Conference organized by State Bank of India, he said, “I am not persuaded by the Reserve Bank of India’s monetary policy statements, including that of the governor, regarding the rush down for these rate cuts… It is very clear that this assumption [of rate cuts delivering growth] is not working in a simplistic way for some time now. Transmission is not happening.”
Roy, a former member of the Economic Advisory Council to the Prime Minister, said there is an “additional danger” posed by the lack of any known analysis done by the central bank on this issue.
The Reserve Bank of India has reduced rates by a cumulative 1.15% in two moves since the onset of the Covid-19 pandemic, on top of cuts of over one percentage point before that with an eye on sagging growth, which slipped to 4.2% in FY20. The central bank’s next Monetary Policy Committee, which will decide on interest rates, is scheduled for August 4-6.
At the same function, Reserve Bank of India Governor Shaktikanta Das said the country’s economy was showing signs of growth after the easing of lockdown restrictions. Regarding the health of the banks, he said the central bank’s multi-pronged approach had cushioned them from the impact of the pandemic for the time being, but the medium-term outlook was uncertain and would depend on how the Covid-19 crisis unfolds.
India has so far witnessed more than 800,000 coronavirus cases, the third-highest rate of infection in the world after the US and Brazil. Health experts caution that the country was not doing enough testing and that the number of cases would rise at a faster rate in the coming months and overwhelm the healthcare infrastructure in many cities.
Das said building buffers and raising capital would be crucial not only to ensure credit flows but to ensure resilience in the financial system. He said banks must identify vulnerabilities early and raise capital before it is urgently required.
“While banks must identify their weaknesses and strengths in how to deal with the current pandemic, such events could be frequent in the coming days and the financial system has to remain prepared. Financial stability is as important as pursuing growth,” he said.
The central bank governor said every financial institution, especially banks, will have to do a Covid-19 stress test, “identify vulnerability and raise capital in time.” The minimum capital requirements of banks, which are based on historical loss events, may no longer be considered sufficient for absorbing losses.
“Meeting the minimum capital requirement is necessary, but not a sufficient condition for financial stability,” he added.
Many global financial institutions, including the International Monetary Fund, have projected a sharp contraction in the Indian economy for the coming fiscal due to the unprecedented stalling of economic activities due to the coronavirus pandemic.