Liquidity push won’t be enough

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In five tranches, Finance Minister unveiled the details of Rs 20 lakh crore economic package with the theme of “Atma Nirbhar Bharat”. The economic cost associated with Covid-19 has been high, and governments across the globe came up with various measures to support the economy. As a first step, Government of India also announced measures worth of Rs 1.73 lakh crore. However, it seemed to be inadequate considering the damage caused by Covid-19 on the economy. In this background, Prime Minister announced an economic package costing Rs 20 lakh crore, i.e. around 10 percent of India’s GDP.

Liquidity Measures

The central pillar of the economic package has been the liquidity support measures. The liquidity measures announced by the RBI amounts to Rs 8.04 lakh crore, which is around 40 percent of the total package. The measures include cut in Cash Reserve Ratio (CRR) by 100 bps, Long Term Repo Operations (LTRO), and credit facility to mutual funds. Other than these measures, Central Bank has implemented various other schemes to ensure liquidity in the market. However, the effectiveness of these measures was limited, as it didn’t necessarily translate to higher credit take off. The debate on the customers not getting benefited from the monetary stimulus of the Central Bank is still going on. The risk aversion among the banks is often cited as one of the reasons for the liquidity crunch in the economy. To combat it, Finance Minister announced various measures to encourage the banks to lend more. The government announced Rs 3 lakh crore collateral free loans for business including MSMEs. As these loans come with full government guarantee, it could encourage the banks to step up its lending to businesses.

For the NBFC sector, Rs 30,000 crore has been announced as special liquidity scheme. Under this scheme, investments will be made both in primary and secondary market transactions in investment grade debt papers. The securities will be fully guaranteed by the government. Similarly, Finance Minister extended partial credit guarantee worth Rs 45,000 crore to AA and below rated papers for which first 20 percent loss will be borne by the government. The risk aversion among investors on low rated NBFC papers has added more layers to the liquidity crisis in the NBFC sector. However, it needs to be looked into whether the partial credit guarantee scheme will be sufficient to aid the stressed NBFC sector. Targeted Long-Term Repo Operation (TLRO) by the RBI directed towards helping the NBFC had only limited response from the banks. 

Reform Measures

The government has utilized the crisis as an opportunity to announce some of the much need reforms. The reform measures such as the amendment of essential commodities act, removing the barriers for farmers to conduct inter-state trade, opening up more sectors for private participation, enhancing the FDI limit in defence, etc are welcoming. These measures could be a game changer to the economy. However, it needs to be stressed that there won’t be any immediate impact, as its impact could be witnessed only in the medium to long term.

Will it be enough?

Now, the question is whether the measures announced in the package will be sufficient to deal with the current crisis? The major criticism of the economic package is that it lacks measures to revive consumption demand in the economy. The expectation was that as part of the stimulus package, government would announce some tax breaks and increase its spending to boost demand. However, apart from the additional Rs 40,000 crore allocated to MGNREGA, government didn’t go overboard in spending. In the Indian scenario, consumption expenditure has a share of around 60 percent in the total GDP. The number clearly shows that the revival of demand is critical for the Indian economy.  

The weak fiscal position forced the government to restrict the stimulus package. It is well factored that in FY21, the exchequer would be facing revenue crunch with the falling tax revenue, and difficulty in realising the disinvestment target. The government has also revised its borrowing plans for FY21, and won’t be able to achieve the fiscal deficit target of 3.5 percent. The increased spending through borrowing would result in the fiscal deficit settling at a higher range. Though the need for monetisation of deficit is widely debated, it is a risky affair. Unlike the US dollar, which is safe haven, printing money in the Indian scenario can have other repercussions. It could lead to the fall in the value of Indian rupee, outflow of foreign investors, downgrading by the credit rating agencies, and other macroeconomic issues. In such a scenario, the cost to the economy would be much higher.

In the present scenario, measures to boost liquidity alone won’t serve the purpose. More concrete measures are needed from the government as the economy is passing through one of its toughest phases. Though widening of fiscal deficit can disturb the fiscal consolidation path, considering the present situation the government has only limited choice.

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