Date: 16/12/2022

Relevance: GS-3: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment; Changes in Monetary Policy and their Effects on Industrial Growth.

Key Phrases: Real and Financial sectors, Balance Sheet, Reserve Bank of India, Trade surplus, Purchasing Power of Currency, Global Financial crisis 2008, Expansionary policy, Volatile Nature, Dollar Currency, Central Bank, Calibrated manner.

Context:

• Post covid, the RBI took a different way of recovering the distressed economy than the approach of the central banks of the advanced economies.

Key Highlights:

• During the pandemic of covid, the central banks of advanced economies decided to print unlimited amounts of money and distribute it among their people. But, the RBI adopted a far more conservative approach, turning away from ‘helicopter money’.
• But despite this guarded approach, the Indian central bank’s balance sheet has increased over 50 per cent during the pandemic.

Different situations for the central banks of advanced economies and the RBI:

• The situation in which the RBI finds itself in is less challenging than the situation that other central banks such as the US Federal Reserve, European Central Bank and the Bank of England face. Because-
  • These central banks had been printing money to stave off recession since the global financial crisis in 2008.
  • Their assets and liabilities were therefore already elevated at the onset of the pandemic. The pandemic-related stimulus has only made matters worse.
• For example, the Federal Reserve’s balance sheet was around $900 billion in July 2008 which expanded to $4.17 trillion by February 2020 and further to $8.7 trillion by December 2021.
• Similarly, the trajectory also followed the same trend for the ECB and the Bank of England.

Consequences of the Monetary Expansions:

• Such expansionary policies have implications for both real and financial sectors of the economy.
• Any accumulation of assets implies an increase in corresponding liabilities. In addition, the purchase of domestic assets will directly affect their prices, and therefore credit spreads, term premia and long-term interest rates.
• They do create risks – and we must watch these closely.
  • In some historical episodes, central banks did expand their balance sheets too much in order to finance profligate government spending.
  • This often had inflationary results. On other occasions, central banks were too slow in reversing expansionary policies when conditions improved.
• Thus, it impacts inflation, endangers financial stability, causes financial market distortions and creates conflicts in sovereign debt management.

Exit Strategy:

• Because of its critical consequences, the US Fed and other central banks have devised an exit strategy by allowing a portion of the securities which are maturing, to expire.
• However, the RBI has not laid out any specific schedule, but its holding of domestic and foreign securities is beginning to move lower. So it indicates the downfall of RBI’s asset side.

RBI’s approach during Covid:

• During covid pandemic, economic activities came to a standstill following the lock-downs so government support was needed to help the distressed sectors of the Indian economy.
• So the RBI had to roll out a series of announcements to borrowers as well as back the government borrowing which had shot up during the pandemic crisis.
• RBI’s balance sheet witnessed the sharpest jump in recent years in 2019-20; growing 30 per cent, to ₹53.3-lakh crore.
  • Since RBI’s accounting period was from July to June until FY21, the excruciating period in the first quarter of the pandemic was captured in the accounts of 2019-20.
• The growth in FY21 and FY22 was however more moderate, at 6.99 per cent and 9.70 per cent.
• Foreign securities increased as the strong foreign portfolio flows were mopped up to increase forex reserves.
• The RBI’s assets have grown roughly from ₹41-lakh crore to ₹62-lakh crore between FY19 and FY22.
  • This expansion needs to be corrected because of the following risks-
    • Besides the inflationary impact and the financial market disruption, there is also market risk.
    • The value of the investment (asset side of the balance sheet) could decline while the value of liabilities remains the same. This can create problems in meeting payment obligations.

Bright Indication of the Economy:

• Contraction in the Balance sheet of the RBI
  • The contraction of the RBI balance sheet has begun.
    • RBI’s total assets have declined to ₹58.57-lakh crore as on October 28, 2022 from the ₹62.61-lakh crore as per March 2022.
  • The contraction seems to have been the result of many factors.
    • One, the sharp rupee depreciation in this fiscal year resulted in the RBI using its forex reserves, accumulated during the pandemic, to defend the currency.
    • Recent increase in CRR by 50 basis points in May this year could have resulted in slight improvement in bank deposits with the central bank, but with demand for credit improving, short-term money parked by banks with the RBI under the LAF corridor has shrunk.
• Lowering of the holding of Government Securities
  • RBI’s holding of dated government of India securities is coming down.
    • Towards the end of September 2022, the central bank held around ₹13.9-lakh crore of dated government bonds which is lower than the ₹14.17-lakh crore of March 2022.
    • This implies that the central bank has begun reducing its holding of G-secs in a calibrated manner. It is a good sign for the stability of the Indian economy.

Way Forward:

• But the exit from expansionary policy is not so easy, especially with growth being quite nebulous, threatened by a host of external risks.
  • The winding down of the securities accumulated over the last few years is likely to move in fits and starts and take time.
• With the fiscal deficit likely to be elevated due to the additional expenditure having to be borne by the government to support the economy, public debt management will continue to pose difficulties.

Conclusion:

• This way is not easy for the RBI but it is a welcome sign to reduce the assets because it is the way forward in controlling inflation in the economy and for a sustainable and inclusive growth of the Indian economy.

Source: BusinessLine

Mains Question:

Q. What are the implications of the expansionary policy of the central bank? Differentiate the approach of the RBI as compared to the central banks of other advanced economies. (250 Words).