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Coronavirus outbreak: Damage to India's economy has been contained by quick policy decisions; imperative that RBI cuts rates only if needed

Sanju Verma

The Federal Open Market Committee (FOMC) cut interest rates back to its financial-crisis-era policy range of between 0 percent and 0.25 percent on 15 March 2020. It also announced it would buy at least $700 billion of bonds akin to a quantitative easing (QE), in coming months, with $500 billion going into Treasuries and another $200 billion going into mortgage-backed securities (MBS).The Fed rate cut to zero came just days after a surprise 50 basis point cut on 4 March 2020,when rates were reduced to the range of between 1 and 1.25 percent. Bank of Canada cut its target too for the overnight rate to 1.25 percent from 1.75 percent, that day.

The Fed's moves were not sufficient to support stock-markets. On 16 March, the Dow Jones collapsed by almost 3,000 points, its worst crash since 1987, bringing the overall fall in the Dow to 30 percent from its recent highs,confirming technically that the Dow had moved into 'bear' territory,as per conventional tools and logic. S&P 500 and Nasdaq lost about 12 percent each on this Black Monday. Apart from the Fed's $700 billion "QE" announcement, the New York Fed also committed to a short-term bond buyback programme of an additional $500 billion.

On 16 March, the UK also decided to pump in £1.46 billion in overnight repo operations. This,after the Bank of England (BoE) had already cut interest rates on 11th March by 50 basis points, for the first time since August 2016, from 0.75 percent to 0.25 percent. BoE maintained its target for government bond purchases at 435 billion pounds and its corporate bond purchase target of 10 billion pounds.The BoE also introduced a new term funding scheme for small businesses. It will offer four-year funding over the next 12 months. The BoE's Financial Policy Committee (FPC), also lowered the counter-cyclical capital buffer for banks to zero from 1 percent. The Bank of Japan announced a bond buyback of 121.6 billion Yen.

A few days earlier, Germany had announced unlimited loans and cash to businesses, affected by the Chinese coronavirus or Wuhan virus, as it should be rightfully called. Reserve Bank of Australia also lowered its benchmark rate to 0.5 percent, the lowest in a long time, to battle tattered markets and battered confidence.

The COVID-19 has in the last few weekswiped out over 8 trillion dollars from global markets,including over $5 trillion from the US markets, alone,as per reports. Microsoft and Apple, have together lost more than a trillion dollars,between them,from their recent peaks.

In its worst fall since 1991, Brent crude fell to its lowest since 11 February 2016 by over 30 percent to less than $30 per barrel, to trade at $28.82 per barrel on 16 March. In a telling sign of overall demand destruction, the global carnage driven by the Wuhan virus has been non discriminatory--from equities, bonds, oil and base metals, to bitcoin and palladium, everything is down between 10 percent and 60 percent, maybe more,since the start of January 2020.

Barely a week ago, the world was still "normal", or let's say,"functional". In just a few days' time, there has been a proliferation of school cancellations, mass gathering prohibitions, sealing of land borders, suspension of all travel and tourist visas, self imposed social distancing, large scale quarantining, grounding of flights, cancellation of all global sporting events, and mandatory telework orders.

Restaurants, gyms, cinema halls and pubs closures are happening across the board. Pretty much, large parts of the globe are in some form of a lockdown. Initial optimism about how "this too shall pass", has now been completely taken over by fear, unprecedented panic and in terms of sentiment, it maybe even worse than the Spanish Flu of 1918. All this said, will the world overcome this? Of course, yes! Social distancing and the insurmountable human will to survive, will eventually win the war against this Chinese virus,amongst other things.

True, in the short term, global asset markets will remain volatile and stabilise only after China stabilises. Don't forget, China is the world's biggest consumer of automobiles, smartphones and luxury goods, with Chinese consumers spending $250 billion every year on travel alone. About 50 percent of Mongolia's coal, 25 percent of Tesla's electric cars, 25 percent of America's soya beans and over 30 percent of Australia's irone ore,coal, beef,baby food and wine, are exported to China.

India's direct export and import linkages to China and Hong Kong are 9 percent and 17 percent, respectively. India is therefore, relatively better off and significantly benefits from falling international oil prices. For every crude price fall by one dollar per barrel, India's import bill shrinks by Rs 2,936 crore. If exchange rate depreciates a rupee to a dollar, import bill increases by Rs 2729 crore. The rupee has been hovering around 74 to a dollar, of late.

Assuming the exchange rate does not change much, every dollar per barrel drop in oil prices internationally, will reduce India's import bill by Rs 10,700 crore. In the past few weeks,the fall in oil prices by over $20 per barrel, should help India to the tune of $32 billion in terms of lower import bill,lower trade deficit and lower current account deficit.

As for the liquidity gush unleashed by global central bankers,well, loose credit will do very little to stoke demand when tens of millions of people go into lockdown. Airlines are on track to cut flights by 75 percent for April and May, with the likes of Ryanair, Qantas and Norwegian Air, virtually grounded and laying off 80-90 percent of their staff.

Pierre Andurand, who runs oil hedge fund Andurand Capital Management, said that oil demand could fall by 10 million barrels per day (mb/d) for a period of time, a contraction with no historical precedent. Oil trading giant Trafigura agreed on the 10-mb/d demand destruction estimate, and said demand could race downhill even further.

Amidst the Corona outbreak and despite aggressive rate cuts and massive amounts of liquidity being injected into money markets, US stocks and US bonds have both, sold off simultaneously in the last few weeks€"a rare occurrence--as leveraged investors sought to unwind positions by selling long-term Treasuries. The flight to safety and strong risk aversion across the board, can also be guaged from the fact that the UK 10 year bond yield recently fell to a record low of 0.26 percent, while the yield on 10 year German Bunds, after a recent low of -0.91 percent, closed at -0.476 percent, on 16 March 2020.

The global stock market crash of 2020 is different from the "Lehman meltdown" of 2008. Bringing rates to zero then, helped, as banks were facing a liquidity crisis that was threatening to become a solvency crisis.This time, the problem is not liquidity--the problem is fear, which has completely taken over sanity and, demolished sane reasoning. When fear and panic rule, zero or negative interest rates will not work, as people postpone all purchases including those of stocks and bonds, expecting prices will fall further and things will be cheaper, tomorrow.

While zero or negative interest rates are a strong incentive to borrow, it is difficult to understand why a lender would be willing to provide funds, considering the lender is the one taking the risk of a loan default. While seemingly inconceivable, there may be times when central banks run out of policy options to stimulate the economy and,turn to the desperate measure of negative interest rates.

Negative interest rates are an unconventional monetary policy tool. They were first deployed by Sweden's central bank in July 2009 when the bank cut its overnight deposit rate to -0.25 percent. The European Central Bank (ECB), followed suit in June 2014 when it lowered its deposit rate to -0.1 percent, before bringing it to -0.5 percent, currently. Don't forget, with Eurozone inflation at -0.6 percent in February 2015, the ECB continued with negative rates as it was running short of other options and any other form of firepower. European countries and Japan have since, chosen negative interest rates, resulting in over $13 trillion worth of government debt carrying negative yields in 2019.

Also,while it may make sense for the US or Europe to have zero or negative interest rates, as that would lower the value of the euro and the dollar and help boost the exports of these countries, there is no reason why India should have very low nominal interest rates, given that the rupee has been trading at 74 to the dollar, in any case. Empirical evidence has shown that in India's case, beyond a point,rupee depreciation may not necessarily push up exports but, it will certainly raise the risks of importing inflation.

Negative interest rates, meant to ward off a deflationary spiral, are a drastic measure that need to be employed in the rarest of cases, with extreme caution and even then, there is no guarantee of success. During times of weak business and consumer confidence, people and businesses tend to hold on to their cash while they wait for the economy to improve. But this behavior can weaken the economy further, as a lack of spending causes further job losses, lowers profits and reinforces people's fears, giving them even more incentive to hoard. Negative interest rates in such a scenario can play havoc.

Of late, there has been a hostile clamour by some market participants in India, for a rate cut from the Reserve Bank of India (RBI). Well,the RBI cut the repurchase rate (repo) rate by a solid 135 basis points in 2019, to 5.15 percent. Also, with India's 10 year bond yield hovering at 6.22 percent levels and retail inflation in February 2020 at 6.58 percent, if anything, the RBI should, logically speaking,raise rates and not reduce rates! The same group that wants the RBI to cut lending rates to help borrowers, was the same that cried foul when the Narendra Modi government decided to the cut the employee provident fund (EPF) rate from 8.65 percent to 8.5 percent. Enjoying small savings rates at more than 8 percent and at the same time a repo rate reduced to less than 5 percent militates against reason.

Again, there is little reason in asking for lending rates at zero like the US. Don't forget, the US 10-year bond yield closed at 0.722 percent on 16 March 2020. US annualised headline inflation last month, stood at 2.4 percent, while core inflation was barely 0.2 percent.

Core inflation in India last month was 4.1 percent, down from 4.8 percent in January 2020.RBI has,in fact,been ahead of the curve all through 2019, in slashing rates, when rest of the world was in a "wait and watch mode". So indeed, if the RBI has chosen to take a well deserved pause, it is in sync with ground realities and the evolving dynamics. A country like India, fighting hard to resolve the non performing assets (NPA) issue, left behind by the erstwhile corrupt Congress regime, cannot afford to have low lending rates and high deposit rates as that would jeopardise the balance sheets of the banking sector and squeeze profit margins.

The RBI should cut rates only if it needs to and when it wants to--not because other central banks are doing so. The RBI has in any case, committed to infusing Rs 1 lakh crore worth of liquidity via long term repo operations (LTROs). Also, the recent $2 billion dollar-rupee sell/buy swap on 16 March 2020 with another one of a similar amount coming up in a week's time on 23 March, to stabilise India's forex markets, is another instance of the coronavirus outbreak not being allowed to overwhelm India's financial markets. If anything, India has been a classic textbook case, showcasing to the world how crisis management under a proactive leadership, can effectively navigate,even the path less trodden, during a global pandemic.

(The writer is an economist and the chief spokesperson of BJP, Mumbai€‹)

Also See: Rupee plunges 45 paise to 74.20 against dollar in early trade amid weak opening in domestic equities, foreign fund outflows

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