This post has been authored by Somnath Ingole , Economic Analyst Intern at Arthashatra Intelligence

The Covid-19 crisis has proved to be an exceptionally different crisis with more complexity and uncertainty than any past global crisis. This crisis brought a synchronised and deep global recession, where the world\’s GDP shrank by 3.5% in 2020, which is the worst contraction since the Great depression. In addition to the crisis, there has been a tremendous shift in the various policy tools used by central banks of different countries, and one of them is monetary policy.

Looking at the global scenario of central banks\’ monetary policy, most central banks reduced their policy interest rates significantly. The chart shows the policy rates of major banks before and after the pandemic. The difference between pre-pandemic policy rates and post-pandemic policy rates is remarkable.

But having a significant reduction in the policy rate was not enough to tackle the Covid-19 crisis. Central banks had to look for more unconventional monetary policy tools; hence most of the banks went with unconventional monetary policy, which they had used in the time of the global financial crisis of 2008-09. The difference between the two monetary policies is that- conventional tools involve changing the target for short-term policy interest rates to achieve the economic objectives (keeping inflation below upper bound, attaining growth, etc.,) and unconventional monetary policy occurs when central banks use different measures rather than simply changing the policy interest rate. So, most of the central banks applied these tools efficiently with some improvements. We can view these tools used by central banks from the table below.

Table 1: Response of major economies to covid-19 pandemic

The table shows the various measures taken by central banks of a few major country\’s. One, cuts in policy rates and forward guidance to support the aggregate demand in the economy, which helps to rebound the economy. Most of the central banks of the US, Chile, UK, Australia, and New Zealand cut their policy rate till effective lower bound. Besides this, many central banks used forward guidance with rate cuts. Second, the US, Chile, and the UK central banks focused on buying government securities to reduce the balance sheet risk limits of the dealers and easing market dislocations. Bank of Japan increased its limit of purchasing government bonds, and other central banks like the Fed, Bank of England, focused on purchasing private assets. Some central banks\’ asset programmes became more extensive than usual and central banks of Korea, Israel, Norway relied on small asset purchase programmes. Russia didn\’t adopt any asset purchase programme. Third, all central banks have provided liquidity provision and credit support to their financial institutions to maintain the easy availability of credit. Also, they tried to provide credit through the purchase of commercial paper and corporate bonds.

RBI\’s approach

RBI adopted an inflation-targeting framework in 2016. In this framework, the repo rate is the signalling rate, which RBI uses to lend money to commercial banks through its liquidity adjustment facility. Weighted average call money rate is used in this framework as an operating target, representing the transactions conducted in the overnight money market. The liquidity adjustment facility maintains the interest rate corridor between the interest rate of a marginal standing facility as upper bound and fixed reverse repo rate as lower bound. The RBI also used unconventional monetary policy tools along with its inflation targeting motto.

So as the pandemic begins, RBI quickly responded to the crisis, and decisions were made to ensure its objective. RBI decided to cut the rate with the accommodative stance, reduced its policy repo rate from 5.15 to 4% throughout the last year and continued until this June 2021\’s monetary policy. So the whole reduction in the policy repo rate was 115 bps and in cash reserve ratio was by 100 bps. The journey of RBI\’s major rates can be seen from the following graph.

In unconventional monetary policy tools, RBI used forward guidance for the first time along with other measures. Forward guidance is the central banks\’ communication on the stance of its monetary policy in the future. RBI stated in its monetary policy report that it would continue with an accommodative stance till reviving growth on a durable basis and maintaining inflation within the target.

RBI introduced long-term repo operations (LTROs), which helps transmit monetary policy and credit offtake and targeted long-term operations (TLTROs) to provide liquidity to those sectors and entities under stress. To alleviate the liquidity stress, RBI provided ₹60,000 Cr at the policy rate to NABARD, SIDBI and NHB. With some other measures, the total liquidity injection stands for 13.6 trillion, which is 6.9% of GDP by March 31, 2021. Also, RBI maintained an active asset purchase programme of government securities through open market operations which amounted to about ₹3.13 trillion or 1.5% of GDP in the year 2021. RBI has conducted special Open Market Operations(OMO\’s) through operation twist, which involves the simultaneous purchase of long-term government securities and selling related short-term securities of the same amount in a liquidity neutral fashion. Such operations aim to compress the term premium and reduce the steepness of the yield curve. RBI conducted 19 operations with a worth of 2 trillion.

RBI\’s Monetary Policy Committee worked on three crucial objectives, first to mitigate the adverse effects of the virus; second, maintaining financial stability in the economy and third, reviving the growth. All the steps were taken to ensure the effective transmission of monetary policy, keeping the financial market and financial system sound and liquid, bearable financial strain on households and business, facilitating the funds through market borrowing for government and state government and maintaining the constant flow of currency in the whole country.

References:

• Data from Bank of International Settlements’ and Reserve Bank of India.
• English, Forbes, and Ubide. 2021. “Monetary policy and central banking in the Covid era: Key insights and challenges for the future. CEPR Press. 3:27
• Mohan, Rakesh. 2021. “The response of the Reserve Bank of India to Covid-19: Do Whatever It Takes”. CSEP WP 8.
• RBI (June, 2021). “Monetary Policy Statement, 2021-22.