Central Banking in Uncertain Times: The Indian Experience
Opening Plenary Address by Shri Shaktikanta Das, Governor
Reserve Bank of India
Delivered at the Summer Meetings organised by Central Banking,
London, UK on June 13, 2023
In recent times, especially since the outbreak of the COVID-19
pandemic, central banks - who are at the core of monetary and
financial systems - have been called to do "heavy lifting" well beyond
their traditional mandate. Central banks have navigated through
unchartered waters during the three black swan events - the pandemic,
the war in Ukraine and the unprecedented scale and pace of global
monetary policy normalisation - all in the span of three years. More
recently, central banks had to quickly change gears from providing
stimulus to pandemic ravaged economies to battling inflation with all
ammunition at their disposal. Even as the battle against inflation was
ongoing, the banking turmoil in certain advanced economies (AEs)
posed the awkward trade-off between financial stability and price
stability. This extraordinary period of global turbulence has indeed been
extremely challenging for central banks and central banking.
2. In my address today, I propose to highlight the Reserve Bank of
India's response to the multiple challenges of COVID-19, surge in
inflation, growth slowdown and threats to financial stability. I also
propose to enumerate the lessons learnt which may become a part of
central bank operating procedure for such events in the future.
COVID-19 Response
3. The COVID-19 pandemic scarred the global economy, causing
unimaginable loss of life and livelihood. In India, our response amidst
the imposition of nation-wide lockdown and social distancing was
prompt and decisive. We were perhaps amongst the first few central
banks to have set up a special quarantine facility with about 200
officers, staff and service providers, engaged in critical activities to
ensure business continuity in banking and financial market operations
and payment systems. Our monetary policy committee (MPC) reacted
swiftly by reducing the policy repo rate sizeably by 115 bps in a span of
two months (March-May 2020). Unlike advanced economy (AE) central
banks which eased rates close to the zero-lower bound, we did not
reduce the policy repo rate below our inflation target of 4 per cent.
Together with other actions in the liquidity front, this helped us in
supporting growth without fuelling inflationary pressures. This also
helped in undertaking a faster reversal of stance later, without being
market disruptive.
4. Along with the rate cuts, we infused significant quantum of
liquidity through both conventional and unconventional measures to
stimulate the economy, restore confidence and revive market activity,
while being mindful of the need to ensure that our liquidity augmenting
measures do not engender future fragilities. Our liquidity measures
were unique in several ways: first, liquidity was provided only through
the Reserve Bank's counterparties (banks) for on-lending to stressed
entities/sectors; second, asset purchase programme was for a limited
period of six months and much smaller in size than advanced
economies, and was confined to government securities only; third,
collateral standards were not diluted while offering lending facilities; and
fourth, loan resolution frameworks for COVID-19 related stressed
assets were not open ended but subject to achievement of certain
financial and operational parameters. Moreover, most of our liquidity
injection measures had pre-announced sunset clauses, which helped
in an orderly unwinding of liquidity on their respective terminal dates
without de-anchoring market expectations. Overall, liquidity enhancing
measures worth US$ 227 billion (8.7 per cent of GDP) were announced,
of which funds availed were US$ 157.5 billion (6.0 per cent of GDP).
5. The liquidity infusion measures were mostly concentrated in 2020
but continued in 2021 in view of fresh waves of the pandemic and the
fragile nature of economic recovery. Nevertheless, surplus liquidity was
gradually migrated from the short end to the longer horizon during 2021
through variable rate reverse repo (VRRR) auctions of longer tenors,
which lifted short-term rates from ultra-low levels, thereby obviating
financial stability challenges. This was done by sensitising the market
well in advance through effective communication. Further, recognising
that the yield curve is a public good, the benefits of which accrue to all,
we undertook outright asset purchases and operation twist1 - which
were generally liquidity neutral - to modulate long term G-sec yields.
This, in turn, lowered rates on all instruments benchmarked to prices of
the G-sec yield curve. The resultant congenial conditions allowed
corporates to mobilise large resources and repay high-cost debt from
banks. Such deleveraging by corporates reduced their balance sheet
vulnerabilities and facilitated credit offtake later in 2022-23. The benign
liquidity conditions also enabled the banks to mobilise additional capital
and strengthen their balance sheets to withstand future stress, if any.
Inflation Challenges
6. At the height of the pandemic during 2020 and 2021, the MPC
prioritised growth over inflation, given the frail economic conditions and
notwithstanding intermittent inflationary pressures from supply shocks.
For instance, supply-side pressures had nudged inflation above the
upper tolerance band of 6 per cent in October 2020 and there were
market concerns over the continuation of the accommodative monetary
policy stance. Under these circumstances, we provided both state- and
time-based forward guidance on continuing "with the accommodative
stance of monetary policy as long as necessary - at least during the
current financial year and into the next year ..." as output remained well
below its pre-pandemic level. In the second half of 2020-21, inflation
eased in line with our assessment as supply side pressures abated.
The time-based element of the guidance helped to anchor market
expectations and moderate undue expectations building up at that time
of a possible reversal of the monetary policy stance.
7. In early 2022, inflation was expected to moderate significantly
with a projected average rate of 4.5 per cent for 2022-23, based on an
anticipated normalisation of supply chains, the gradual ebbing of
COVID-19 infections and a normal monsoon. Such expectations,
however, were belied by the outbreak of hostilities in Ukraine since end-
February 2022. Initially, the shocks came from food and fuel prices,
which were mainly global in origin, but local factors from adverse
weather events also played an important role in increasing food
inflation. The shocks to inflation got increasingly generalised over the
ensuing months. Moreover, strengthening domestic recovery and rising
demand enabled pass-through of pent-up input costs to retail goods
and services. This imparted stickiness to underlying core inflation and
kept headline inflation at elevated levels.
8. Under these circumstances, the MPC quickly changed gears by
prioritising inflation over growth and also changed its stance from being
accommodative to withdrawal of accommodation. The MPC acted
proactively by holding an off-cycle meeting in May 2022 and raised the
policy rate by 40 basis points. This was followed by rate hikes, albeit of
varying sizes, in each of the five subsequent meetings till February
2023. In all, we have raised the policy repo rate by 250 bps cumulatively
between May 2022 and February 2023. Thus, we acted in a timely
manner and have calibrated the quantum of rate hike with the changing
inflation outlook. In recent months, there are signs of some softening in
inflation, with headline inflation easing to 4.25 per cent in May 2023
from the peak of 7.8 per cent in April 2022.
9. The cumulative impact of our monetary policy actions over the last
one year is still unfolding and yet to materialise fully. While our inflation
projection for the current financial year 2023-24 is lower at 5.1 per cent,
it would still be well above the target. As per our current assessment,
the disinflation process is likely to be slow and protracted with
convergence to the inflation target of 4 per cent being achieved over
the medium-term. Based on this realisation and with a view to assess
the impact of past actions, we decided on a pause in the April and June
2023 meetings, but clarified unequivocally that this not a pivot - not a
definitive change in policy direction. Recognising that explicit guidance
in a rate tightening cycle is inherently fraught with risks, the MPC has
also eschewed from providing any future guidance on the timing and
level of the terminal rate.
Growth concerns
10. In India, with the formal adoption of flexible inflation targeting (FIT)
in 2016, the Reserve Bank of India is entrusted with the responsibility
of conducting monetary policy with the primary objective of "maintaining
price stability while keeping in mind the objective of growth". Given our
population2 and large addition to the work force every year because of
the "demographic dividend",3 we cannot be oblivious to growth
concerns. Hence, we prioritised growth during the pandemic years even
as inflation remained above the target but within the tolerance band.
11. The Indian economy displayed exemplary resilience post-
pandemic and rebounded strongly from a contraction of 5.8 per cent in
2020-21 to a growth of 9.1 per cent in 2021-22 and 7.2 per cent in 2022-
23. Proactive and coordinated response of fiscal and monetary policies
nurtured a quick recovery, while various structural reforms related to
banking, digitalisation, taxation, manufacturing and labour,
implemented in the last few years, laid the foundation for strong and
sustainable growth over the medium and long term. The government's
continued thrust on capital expenditure is creating additional capacity
and nurturing the much-awaited revival in the corporate investment
cycle.4 The Indian economy has also made rapid gains in openness
and has gradually integrated with the global economy over the years.
Consequently, it is getting increasingly exposed to the vagaries of
global headwinds. It is, however, pertinent to note that India's growth in
the last few years is mainly driven by robust domestic demand,
especially private consumption and investment, amidst the global
slowdown5. Looking ahead, we expect real GDP to grow by 6.5 per cent
during 2023-24. In all likelihood, India will remain among the fastest
growing large economies in 2023.
Regulatory and Supervisory Initiatives
12. In the last few years, we have put in place a stronger and more
robust regulatory and supervisory framework. This has served us well
in withstanding the scourge of the pandemic and the global financial
market turmoil after the outbreak of geo-political hostilities. Our
approach to regulation and supervision has been essentially premised
on three pillars.
13. First, our focus in recent years has been to strengthen
governance and assurance functions within our regulated entities -
banks and non-bank financial companies (NBFCs). The emphasis has
been on building an environment of trust, transparency and
accountability in the financial sector. Some of our regulatory measures
include implementation of (i) Liquidity coverage ratio (LCR) and net
stable funding ratio (NSFR); (ii) governance guidelines for commercial
banks; (iii) scale-based regulatory (SBR) framework for non-banking
financial companies (NBFCs), among others. The capital and liquidity
requirements are uniformly applied to all scheduled commercial banks
(SCBs), irrespective of their asset size and exposure.6 Latest
supervisory data indicates that all the banks are meeting the various
prudential requirements. Stress tests also indicate that even in severe
stress conditions, Indian banks will be able to meet the minimum
requirements.
14. Second, our supervisory systems have been strengthened
significantly in recent years by adopting a unified and harmonised
supervisory approach for commercial banks, NBFCs and urban
cooperative banks (UCBs).7 We have considerably strengthened
supervisory macro and micro data analytics to capture potential and
emerging risks. Overall, unification of supervisory architecture;
ownership-agnostic and risk-focused supervision; shift from episodic to
continuous supervision; enhanced off-site surveillance, leveraging on
data analytics and SupTech solutions; strengthened on-site
supervision; outlier entities identification and deep-dive into vulnerable
areas have been the major planks of our supervisory strategy.
15. Third, we focus on identifying and addressing the root causes of
vulnerabilities in banks and financial entities rather than dealing with
the symptoms alone. We deep dive into the business models of banks
and other lending entities and closely monitor their asset liability
mismatches and funding stability. We have a system of early warning
signals that provide lead indications of risk build-up. Stress tests are
also carried out on a continuous basis for both individual entities as well
as at the systemic level. We do not interfere with the business decision
making of regulated entities, but our approach is to sensitise the senior
management of regulated entities for remedial action on any mismatch
between the adequacy of internal controls and loss absorption capacity
and the risks that their business models generate. We also remain
engaged with the external auditors to flag issues that are relevant for
their role.
16. Summing up, our approach towards maintaining the stability of
the Indian financial system is integral to our conduct of monetary policy
as financial instabilities can undermine economic growth and impede
monetary policy transmission. We recognize that the likelihood of
financial turbulence would be high if there is no price stability. This
reinforces our belief in the complementarity of monetary policy and
financial stability in the long run.
Effective Communication
17. At the Reserve Bank, we are mindful of the importance of
communication, given our multifarious responsibilities and wider
ramifications of our actions. We have followed a consultative approach
by periodically interacting with various stakeholders on policy
formulation.8
18. Central bank communication was tested to the hilt and on two
major counts as the pandemic unfolded: (a) we had only the digital
interface to communicate with media and other stakeholders, and (b)
the target audience changed from experts to the general public with
attendant challenges9. The communication during pandemic times,
apart from explaining the measures being taken by RBI, were also a
source of confidence and optimism for the common man. The April
2020 statement made by me stated "Although social distancing
separates us, we stand united and resolute. Eventually, we shall cure;
and we shall endure". The August 2020 monetary policy statement
made by me said, "The pandemic poses a challenge of epic
proportions, but our collective efforts, intrepid choices, innovations, and
true grit will eventually take us to victory". These and other such
messages reinstated the much-needed confidence, provided market
guidance and helped anchor expectations, all of which are important
elements of a modern monetary policy framework.
19. The Reserve Bank's pandemic response was prompt and
decisive, with more than 100 measures undertaken since March 2020.
The MPC meetings were held ahead of the schedule on two occasions
(March and May 2020). I also delivered two other standalone
statements outside the Monetary Policy Committee (MPC) cycle - one
in April 2020 and the other in May 2021, the latter at the peak of the
second (Delta) wave of COVID-19. These off-cycle meetings and
standalone statements demonstrated the Reserve Bank's readiness to
undertake prompt and pre-emptive actions. The unequivocal
reassurance communicated to the public and other stakeholders
through these statements along with our timely measures eased
financial conditions considerably while unfreezing markets and reviving
trading activity.
20. Effective forward guidance reinforced the impact of our
conventional and non-conventional monetary policy actions during the
pandemic. As noted earlier, our forward guidance on continuing with
accommodative monetary policy amidst transient inflationary shocks
was highly effective. Our asset purchase programme - G-sec
Acquisition Programme (G-SAP) - provided an upfront commitment to
a specific amount of open market purchase of government securities.
This measure anchored interest rate expectations and facilitated
monetary transmission.
21. Recalibrating the policy path after the pandemic presented its own
set of communication challenges. Reversal of certain open-ended
policies required careful and nuanced communication to align market
expectations with our assessment. Illustratively, the Governor's policy
statement of February 2021 addressed the fears of reversal of
monetary policy which were building up due to resumption of liquidity
absorption through VRRR operations in January 2021. This was done
by explicitly explaining the rationale for the reintroduction of VRRR
auctions. Similarly, liquidity rebalancing was set in motion in August
2021 through periodic upscaling of the 14-day main VRRR auction, with
the explanation that liquidity conditions need to "evolve in sync with the
macroeconomic developments to preserve financial stability".
22. The assurance given to the markets, the people and all other
stakeholders through statements like "We will continue to think and act
out of the box, planning for the worst and hoping for the best (June
2021); "The Reserve Bank remains in 'whatever it takes' mode, with a
readiness to deploy all its policy levers - monetary, prudential or
regulatory" (August 2021) demonstrated the central bank's commitment
to remain steadfast in safeguarding trust and confidence in the
domestic financial system.
23. In the subsequent tightening phase which commenced in April-
May, 2022, the scale and nature of communication has been
appropriately fine-tuned and calibrated, so as to ensure successful
transmission of policy rate hikes.
24. We also recognise that communication has to be balanced - too
much of it may confuse the market while too little may keep it guessing.
Communication needs to be backed by commensurate actions to build
credibility. We tread a very fine line and constantly endeavour towards
refining our communication strategies.
Conclusion
25. Let me now conclude by reflecting upon some key lessons that
we have drawn from our experience of the past three years. First, being
proactive and nimble footed during a crisis gives one the agility to
respond speedily to evolving developments that are overwhelming. In
this regard, our decisions at the height of the crisis in 2020 and our
liquidity rebalancing measures in 2021 served us well. Second, our
measures have been prudent, targeted and calibrated to the need of
the hour. We have not been tied down by any existing dogma or
orthodoxy. While lowering the floor of the interest rate corridor and
increasing its width, we did not inject excessive liquidity or dilute our
collateral standards. We kept in mind that what is being rolled out needs
to be rolled back in time and in a non-disruptive manner. Third, we
backed up our monetary policy actions by appropriate regulatory and
supervisory measures, including macro-prudential instruments, that
reinforced the policy impact and its credibility. Fourth, we provided
guidance and confidence to the market and the wider public through
effective communication as part of our endeavour to anchor
expectations and sentiments appropriately. Thus, communication
became an additional pillar of our overall policy response during the
pandemic.
26. In my address today, I have endeavoured to provide a synoptic
view of the Indian experience which may be useful for the ensuing
discussions in this conference. I once again thank the organisers and
Central Banking for this opportunity and wish the Conference all
success.
Thank You.