Coronavirus – Economic Issues

RBI’s job involves trade-offs, not conflicts


From UPSC perspective, the following things are important :

Prelims level: Role of the RBI.

Mains level: Paper 3- Role of the RBI and trade-offs involved in its decisions.

The article discusses three things for the RBI to follow in fulfilling its role, these are- 1) Prudence 2) Flexibility 3) Acting within the mandate. Besides that, problems the RBI has been facing are also discussed. These things are discussed against the backdrop of Covid-19.

Role of the RBI

  • A central bank like the RBI must replace intellectual certainty with the continuous debate over their actions.
  • RBI’s job involves complex trade-offs — next quarter vs quarter century, growth vs stability, and mandates vs expectations.
  • A global anthropological shock-like COVID makes these trade-offs — they are not conflicts — even harder.
  • The RBI must remember three things — acting prudently to balance the next quarter and quarter century, acting flexibly to blunt this economic cataclysm, and acting within their mandate to ensure institutional legitimacy and immunity.

These three things are discussed below-

1. Acting prudently

  • If everybody believed that in the long run we are all dead, we would never sit under trees planted by people who had no chance of sitting under them.
  • The coronavirus is a human tragedy but a central bank must not act like a commercial bank because that would compromise the balance between today and tomorrow.
  • A narcissism — bordering on solipsism — already reflects in global debt levels that steal from our grandchildren.
  • More importantly, India doesn’t have the economic strength to copy the US Federal Reserve’s $2.3 trillion offer to lend to businesses of all sizes and sorts.
  • And run anything close to this year’s expected US fiscal deficit of 15 per cent of GDP, or sustain Japan’s public debt levels at 240 per cent of GDP.
  • We are all in the same storm but we are all not in the same boat.

2. Acting flexibly within the mandate

  • Renaissance physician Paracelsus had important advice for central banks; the dose makes the poison.
  • Anything powerful enough to help has the power to hurt; handling the inevitable tensions between the RBI’s dual mandate of growth and stability requires continuous work.
  • Our inflation targeting regime is a macroeconomic gift to India.
  • But recognising that is hardly inconsistent with acknowledging that inflation’s secular decline has many parents, some economic models are useful but all are incomplete, and the fog of war involves making second-best choices as long as they are reversible, proportional, and accountable.
  • Central banks often undertake liquidity management while leaving policy rates unchanged; current actions are not a conspiracy to undermine the MPC or its interest rate corridor (between reverse repo rate and MSF rate with repo rate midpoint targeting and call rate operating target).
  • They are a pragmatic encouragement for banks to lend to clients rather than lend Rs 7 lakh crore to the RBI.
  • Other virus flexibility includes repayment moratoriums (with 10 per cent provisions), bad loan accounting forbearance (despite past experience of breaking the thermometer doing little for the fever) and bank windows for NBFC/Mutual Fund liquidity.
  • Listening is hardly compromise.
  • Especially if accompanied by a will to unwind liquidity, asymmetry and forbearance when the planet’s gap year ends.

3. Follow the mandate

  • Central bank governance is a fine balance; they function best when they don’t declare separation from the government and they aren’t considered a part of the finance ministry.
  • The difficulty of balance isn’t uniquely Indian.
  • The RBI must build on its track record of wisely balancing the trade-offs between depositors vs borrowers, companies vs banks, and stability vs growth.
  • And it must continue to stay out of the government’s domain.
  • The central bank crisis role debate is skewed by the great book, Lords of Finance, by Liaquat Ahamed that shows how central bankers of the 1920s failed to fight the Great Depression.
  • History matters but nobody knows if this is the beginning or ending of the virus.
  • Yet the global central bank COVID toolbox has been substantial; buying corporate bonds, making corporate loans, cutting interest rates, conducting open market operations, and reducing reserve ratios.
  • Additionally, banks have been permitted to grant loan moratoriums, hold less capital, restructure loans, pay lower deposit insurance premiums and delay bad loan recognition.
  • The emergency authority under Section 13 of the US Federal Reserve Act being used — prematurely — also exists in Section 18 of the RBI Act.
  • But emergency powers are the last resort. We are not there yet.
  • The recovery being V-shaped, U-shaped, or Bathtub-shaped is only modellable after the lockdown.

Pre-existing problems facing the RBI

  • The RBI’s COVID balm is constrained by pre-existing conditions in Indian banking, which are given below-
  • Bad loans which peaked at Rs 14 lakh crore but still large.
  • Inadequate competition- scheduled commercial bank numbers have hovered between 90 and 100 since 1947.
  • Private bank governance- CEO so powerful that boards and shareholders are weak.
  • Public sector bank governance- shareholder so powerful that boards and CEOs are weak.
  • And the RBI’s own game (process, technology and human capital in regulation and supervision).
  • All these must be tackled with urgency when normalcy returns.

A question based on the role of the central bank can be asked by the UPSC. Consider the following question “Crises have always tested the utility of central banks, be it the Great Depression, 2008 financial crisis or Covid-19. In light of this statement, explains the trade-offs involved in the RBI’s decisions and how shocks like Covid-19 makes these trade-offs even harder.”

Way forward

  • Supplementing India’s fiscal and monetary policy interventions by announcing two bold reform plans — 90-day flick-of-pen and one-year structural — that tackle overdue reforms in labour, education, cities, finance, compliance, and civil services, will catalyse hope among employers, employees, banks, and overseas investors.


Creating a prosperous India needs many things. One of them is an independent, accountable, and boundaried central bank that listens.


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