A flood of liquidity by the Reserve Bank of India (RBI) under Shaktikanta Das has been India’s principal instrument of fighting the war against COVID-19, with the economy majorly devastated in the wake of the most stringent economic lockdown imposed anywhere in the world. Finance Minister Nirmala Sitharaman summed it up well. While unveiling the government’s Rs 20 lakh crore stimulus package in May 2020 (10% of India’s GDP), she proudly asserted that 40% of the stimulus package (Rs 8 lakh crore) was in the form of liquidity measures taken by the RBI.
Governor Shaktikanta Das started pushing the liquidity accelerator right from the word go, beginning with his unscheduled address to the media on 27 March 2020.
In the Monetary Policy Report published in October 2021, the RBI states that it took liquidity measures aggregating Rs. 17.22 lakh crore (8.7% of the GDP) between 6 February 2020 to 30 September 2021.
Budgetary fiscal measures against COVID-19, which translated into actual fiscal expenditures from March 2020 to October 2021, did not exceed Rs 3 lakh crore.
Flooding the banking and financial system with liquidity immediately in the aftermath of the complete locking down of the country for 21 days was akin to a surgical strike. Governor Das has maintained a full flow of the liquidity measures during the last 20 months, keeping the financial system in a huge surplus-liquidity mode since then. There is still an excessive systemic liquidity overhang in the system (more than 9 lakh crore as at the end of October 2021).
Liquid-ness of Money is Its Most Useful Attribute
The economic system – production, distribution and consumption of goods and services – works through billions of transactions carried out by the economic agents – firms, workers, buyers, sellers and myriad others. These transactions take place with money interceding with transferor of value receiving equivalent monetary value from the recipient of value. The wheels of the economy can come to a grinding halt if money disappears.
Money is not the same as liquidity, but the ease with which money can intercede between real economy transactions is its liquidness or liquidity. Cash or currency can be transferred instantaneously, which makes currency the most liquid form of money. Besides currency in circulation (approximately Rs 30 lakh crore presently in India), deposits in banks (approximately Rs 145 lakh in current, savings or fixed deposits) also work as money. While current and savings bank deposits have been relatively more liquid, digitalisation of bank accounts has made even most fixed deposits quite liquid. More liquidity makes the money roll over faster. Digital payments are fast expanding in India. Broader money (currency in circulation and deposits in banks) has become much more liquid.
The financial system, most particularly the banks, have to remain quite liquid as well to enable payments, withdrawals of deposits and disbursement of credit seamlessly. For this, the banks keep cash and also deposits with other banks and the RBI.
Money supply improves liquidity. But an excessive supply of money does not, however, necessarily increase the liquidity of money. Extra supply of money over the demand/need of the economic system comes back to the RBI or sits with banks as extra cash.
Demonetisation Destroyed Liquidity, not COVID-19 Lockdown
Shaktikanta Das had the misfortune of handling two catastrophic economic events in the last five years. The demonetisation of Rs 500 and Rs 1000 notes (aggregating more than Rs 15 lakh crore) in November 2016 was far more momentous in destroying liquidity as it drained out more than 80% of the currency by stripping it of its status as legal tender. While demonetisation did have quite a few positive consequences, its money supply and liquidity fallout led to considerable inconvenience to people, and the economic system suffered.
The government struggled to manage the fallout. Hundreds of ad-hoc orders/guidelines were issued to manage money supply and liquidity. Some of these decisions were taken in the heat of the moment – for example, using indelible ink to mark people who had withdrawn the limited Rs 4000 allowance then was simply insane.
The decision to impose a complete lockdown for three weeks in March 2020 struck the economic system badly. Factories stopped, trucks stopped and workers and entrepreneurs got trapped in their homes, or wherever they were on that fateful night. This did bring a massive supply shock to the economy, but it did not impact the monetary supply and liquidity much.
The currency in circulation (at that time around Rs 24 lakh crore) remained intact. Deposits in banks (at that time around Rs 135 lakh crore) were also completely unaffected. The banking system continued to operate normally even when physical access to the bank branches got restricted on account of lockdown restrictions.
The two catastrophic events – demonetisation and the COVID-19-induced lockdown – in fact, presented two completely opposite challenges from a monetary policy/liquidity perspective.
RBI Measures Added Up To Over Rs 17 Lakh Crore
The COVID-19 lockdown crisis was not a liquidity crisis. However, taking no chances, the RBI stepped up liquidity infusion, partly to make up for the government’s reluctance to provide fiscal support to businesses and labour.
The RBI, in the last 20 months, came out with several measures to expand liquidity and lower interest rates in the country. The Cash Reserve Ratio or CRR was cut (released Rs 1.37 lakh crore). Banks were provided with cheaper credit under facilities like the Long Term Repo Operations or LTRO (Rs 2 lakh crore), Variable Rate Repo or VRR (Rs 2.25 lakh crore), Targeted Long Term Repo Operations or TLTRO (Rs 1.5 lakh crore) and quite a few others with esoteric sounding names.
The RBI also came up with quite a few facilities to make ‘liquidity’ reach non-banks and other financial institutions through the banks. These measures cumulatively added up to more than Rs 17 lakh crore, though at any particular point in time, the facilities available were smaller. All these facilities, however, were not fully used.
Liquidity Measures Proved Largely Sterile
Besides serving the primary purpose of maintaining seamless payments in the system, liquidity serves one more important monetary policy purpose – the expansion of credit. Expansion of credit supports investments by businesses in newer projects and capacity addition and by households in durable assets like houses, vehicles, etc. Easier liquidity, accompanied by lower interest rates, does encourage businesses and households to borrow more and bankers and the financial system to lend more.
Unfortunately, the banks could not expand credit during this period. The outstanding credit for the industry group (including all types of industries – micro, small, medium and large and also infrastructure) and the services group has remained quite static overall and declined in many specific segments. Only agriculture (food credit and agriculture credit) and household credit (retail) maintained trend growth during this period.
Overall, credit grew by less than 6.8 per cent during this period. Outstanding industry group credit at the end of March 2020 was Rs 29.05 lakh crore, and services credit was Rs 25.95 lakh crore. Outstanding credit to the industry group was lower in absolute terms at Rs 28.95 lakh crore at the end of March 2021. At the end of August 2021, the outstanding industry credit was only Rs 28.20 lakh crore, about Rs 85,000 crore less than at the start of the pandemic. Services credit outstanding at the end of August 2021 was also only Rs 26.25 lakh crore, almost at the same level as at the end of March 2020. Surely, the liquidity measures of RBI did not contribute to the expansion of credit to industry or the services.
Banks’ Holding of Govt Securities Increased
The payment system functioned quite normally during COVID-19, unaffected by the pandemic or liquidity. Massive liquidity operations carried out by the RBI, by and large, proved sterile.
The RBI measures, however, helped the government raise borrowings at a lower cost.
Expansion of money supply, working in tandem with the measures taken to bring down the interest rates/yield curve of the government securities, helped the government meet its expanded borrowing requirements without much hassles and at much lower effective yield rates than what prevailed during the pre-pandemic period.
Banks’ investment in government securities (central and state governments taken together) grew from Rs 36.85 lakh crore at the end of March 2020 to Rs 44.61 lakh crore by end of March 2021, increasing by Rs 7.76 lakh crore, or by a whopping 21% in a year.
The RBI also helped the government raise its market borrowing by directly buying government securities through various operations, including open market operations or OMOs. The RBI’s investment in government securities increased from Rs 10.4 lakh crore at the end of March 2020 to Rs 13.3 lakh crore (by 30%) at the end of March 2021.
The increase in money supply, usually described as liquidity measures by the RBI, ended up, to a large extent, expanding banks’ holding of government securities, or returned to the RBI as deposits in its reverse repo facilities (more than Rs 9 lakh crore at end-October).
Time to Wind Down Pro Forma Liquidity?
The massive liquidity infusion has been largely pro forma. It has affected neither credit growth nor inflation.
There have been some inflationary pressures in the economy, which are more on account of supply-side issues and a large incidence of taxes on petroleum product prices. Inflation does not seem attributable to the expansion of liquidity.
Thus, as monetary/liquidity measures have proved quite sterile, it would do no harm to the economy if these were wound up and more normal liquidity and financial conditions return to the financial markets.
(The author is an economy, finance and fiscal policy strategist. He is also former Finance and Economic Affairs Secretary of India. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)