What’s in the news?
- In its effort to push start the economy using the post-COVID-19 relief and recovery package, the government has relied heavily on measures aimed at pushing credit to banks, NBFCs and businesses big and small, which are expected to use borrowed funds to lend to others, make payments falling due, compensate employees even while under lockdown, and otherwise spend even while not earning.
- The thrust is to get the RBI and other public financial institutions to infuse liquidity and increase lending by the financial system, by offering the latter capital for longer periods at a repo or policy interest rate that has been cut by more than a percentage point to 4%.
The fourth ‘l’
- The Prime Minister in his speech calling for a “self-reliant India” identified, besides land, labour and laws, “liquidity” as among the areas of focus of the package.
- In economic and business parlance, liquidity refers to ease of access to cash — a liquid asset is one that can be easily sold for or replaced with cash, and a liquid firm or agent is a holder of cash, a line providing access to cash, or assets that can be easily and quickly converted to cash without significant loss of value.
- In periods of crisis, individuals, small businesses, firms, financial institutions and even governments tend to experience a liquidity crunch. Relaxing that crunch is a focus of the government’s crisis-response package.
Focus on NBFCs
- The main intermediaries being enlisted for the task of transmitting liquidity are the banks, with NBFCs constituting a second tier.
- Among the first steps taken by the RBI was the launch of special and ‘targeted’ long term repo operations (TLTROs), which allowed banks to access liquidity at the repo rate to lend to specified clients.
- That funding allowed big business to access cheap capital to substitute for past high-cost debt or finance ongoing projects.
- The TLTROs also focus on infusing liquidity among NBFCs, whose balance sheets were under severe stress even before the COVID-19 strike, because they were finding it difficult to roll over the short-term debt they had incurred to finance longer term projects, including lending to small and medium businesses, housing and real estate.
- Banks were wary about lending to these NBFCs, because of fears that their clients could default in amounts that would bring the viability of these institutions into question.
Additional liquidity infusion efforts
- Building on these initial liquidity infusion efforts, the COVID-19 package identified more intermediaries (such as the Small Industries Development Bank of India, the National Bank for Agriculture and Rural Development, and the National Housing Bank) that could refinance lending by the banks to different sections.
- To persuade the banks and other intermediaries to take up these offers when the clients they must lend to (micro, small and medium enterprises, street vendors, marginal farmers, etc.) are themselves stressed, in some instances the government offered them partial or full credit guarantees in case their clients defaulted.
May not be sufficient
- However, these measures, which are only marginally effective even in the best of times, will not work during this crisis.
- Consider a bank or NBFC lending to small business. With economic activity either at a complete stop or at a fraction of the normal, those who can access credit would either not borrow or only do so to protect themselves and not use the funds either to pay their workers or buy and stock inputs.
- Even after the lockdown is lifted, the compression of demand resulting from the loss of employment and incomes would be considerable. Faced with sluggish demand, firms are unlikely to meet past and current payments commitments and help the revival effort, just because they have access to credit.
- This would mean that credit flow would actually not revive.
On disposable income
- Another component of the “liquidity” push is the measures that temporarily increase the disposable income of different sections.
- Advance access to savings like provident fund contributions, lower tax deduction at source, reduced provident fund contributions and moratoriums on debt service payments for a few months, are expected to provide access to cash inflows and reduce cash outflows, to induce agents to meet overdue payments or just spend to enhance the incomes of others.
- These are marginal in scope, if relevant at all. Overall, the “transmission” of the supply side push from these monetary policy initiatives for relief and revival is bound to be weak.
- What is needed now is government support in the form of new and additional transfers to people in cash and kind, and measures such as wage subsidies, equity support and spending on employment programmes.
- That would require debt financed spending by the government, with borrowing at low interest rates from the central bank or a “monetisation” of the deficit.
- Monetisation of deficit means printing more money. It happens when RBI buys government securities directly from the primary market to fund government’s expenses.
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