Monetary policy has limitations, govt should act more to revive economy: SBI economists
Using a formula, they estimated the "lower bound" of interest rates below which the gains of rate cuts start reversing at 3.5 percent for India as against the Reserve Bank of India’s (RBI) policy repo rate of 4 percent.
by PTIThe country needs to adopt an "activist” fiscal policy rather than depending on the monetary accommodation alone for turning the economic fortunes, economists at SBI said on Monday.
Using a formula, they estimated the "lower bound" of interest rates below which the gains of rate cuts start reversing at 3.5 percent for India as against the Reserve Bank of India’s (RBI) policy repo rate of 4 percent.
The RBI has cut rates by a cumulative 1.15 percentage points since the onset of the coronavirus pandemic but paused at the last review because of high inflation.
The government has promised to spend an additional less than 2 percent of the GDP as part of a stimulus package to help the economy which is much lower than what other nations have done.
COVID-19 Vaccine
Frequently Asked Questions
View more
How does a vaccine work?
A vaccine works by mimicking a natural infection. A vaccine not only induces immune response to protect people from any future COVID-19 infection, but also helps quickly build herd immunity to put an end to the pandemic. Herd immunity occurs when a sufficient percentage of a population becomes immune to a disease, making the spread of disease from person to person unlikely. The good news is that SARS-CoV-2 virus has been fairly stable, which increases the viability of a vaccine.
How many types of vaccines are there?
There are broadly four types of vaccine — one, a vaccine based on the whole virus (this could be either inactivated, or an attenuated [weakened] virus vaccine); two, a non-replicating viral vector vaccine that uses a benign virus as vector that carries the antigen of SARS-CoV; three, nucleic-acid vaccines that have genetic material like DNA and RNA of antigens like spike protein given to a person, helping human cells decode genetic material and produce the vaccine; and four, protein subunit vaccine wherein the recombinant proteins of SARS-COV-2 along with an adjuvant (booster) is given as a vaccine.
What does it take to develop a vaccine of this kind?
Vaccine development is a long, complex process. Unlike drugs that are given to people with a diseased, vaccines are given to healthy people and also vulnerable sections such as children, pregnant women and the elderly. So rigorous tests are compulsory. History says that the fastest time it took to develop a vaccine is five years, but it usually takes double or sometimes triple that time.
"We believe any further rate cuts will have the unintended impact on the economy. Instead, we strongly recommend for India an activist fiscal policy,” the SBI economists said in a note.
"Fiscal expansion is a must,” they added.
In the note, the SBI economists said providing fiscal stimulus is the most effective solution in the current pandemic and it should be taken up immediately by India just like other countries.
They said countries are providing sizable fiscal support through budgetary measures, and off-budget liquidity support measures taken by the governments in the US and Europe to protect vulnerable firms and employees during the lockdown have largely met their goals.
As the exit phase begins, policy needs to pivot toward supporting the recovery, they said adding that in the Indian context, this may include providing fiscal support to help the demand side.
Elaborating on the lower bound of the interest rates, it said such a level is given by the reversal interest rate, at which accommodative monetary policy reverses its effect and becomes contractionary for output.
"If the central bank reduces the policy rate below such 'reversal interest rate', the monetary policy rate depresses rather than stimulates the economy. Importantly, such reversal interest rate is not (necessarily) zero,” they explained.
The economists said they used a 2018 paper to extend the concept of reversal interest rate in the Indian context with suitable modifications and pegged the rate at 3.5 percent.
There is a "clear evidence" of reversal repo rate creeping up over time, and in that sense, banks will always prefer to hold assets of longer duration, they said.
The economists cited the example of bank having assets of a shorter duration and said that in such a scenario, longer interest rate cut might lead to larger net interest income profit losses than fixed income capital gains.