‘Unconventional Monetary Policy’ is a product of the Global Financial Crisis. When time-tested tools like interest rate s did not help much in stabilising financial markets after the Lehman Brothers blow-up, Fed Chairman Ben Bernanke, a student of the Global Depression, cheer-led unconventional actions.
As the financial crisis triggered numerous actions by central bankers across the world, one particular promise made the difference between the survival or the death of financial markets as we knew it –– that of European Central Bank chief Mario Draghi’s in July 2012.
He promised to do “whatever it takes” to ensure that the political conglomerate –– the European Union –– did not collapse because of the economic stress faced by nations on the fringe, like Greece, Portugal, Italy and Spain. Since the GFC broke out, the Reserve Bank of India did its own policy tinkering which addressed the immediate pain but ended up being steroids with negative side-effects like a pile of bad loans.
Although India did not take many unconventional measures then, it seems to be doing so now. The introduction of the $5 billion Rupee-US dollar swap as a tool to address liquidity is a first for the RBI and the market is cheering it.
First, for those doubting Thomases who question what an infusion of $5 billion or Rs 35,000 crore would achieve, it must be said that it may not just be “one and done”. There may be a series. In fact, analysts estimate that there’s room for at least $12 billion of flows if banks decide to raise capital.
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Second, it may mellow the critics of the unprecedented bond purchases through the Open Market Operations which reminded them of those dark days of monetising government debt. Bond purchases of more than Rs 3 lakh crore, or 71% of net government borrowings in a fiscal, creating base money, should be worrying. But doing the same with foreign exchange does not tantamount to monetisation of debt.
It could also address the credit spreads. While OMO was good enough for government bond investors, the lowering of interest rates did not lead to transmission of rates. But this could achieve that.
Non-banking finance companies (NBFCs) which are being treated as untouchables by the local market could have a relief with better-rated companies able to raise dollar funds. Thanks to the central bank’s presence, the forward premium could also ease making hedging a viable tool.
The currency market distortions could also get adjusted. Foreign exchange reserves draw down was $45 billion during the past year when the balance of payment deficit is about $13 billion which reflected that importers were over hedging.
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From a central bank point of view, the proportion of domestic to foreign assets in its balance sheet is also a factor. Domestic assets, which were about 10% of the assets in 2008, is now 31% which could get adjusted with the swap. Its climb has been sharp since August when it was 25%. This may well be Governor Shakthikanta Das’ ‘whatever it takes’ moment.
But what about his deputy, Dr Viral Acharya, the former New York University professor who has produced voluminous work on unconventional monetary policies in Europe and Japan? It is anybody’s guess.
For those in a hurry, there’s a video link too: Click here
In essence, Acharya’s research concludes that Draghi’s promise may have saved the collapse of the European Union but had unintended consequences on the banking system.
Under capitalised banks made poor credit decisions and weakened the financial system further. Those deserving good borrowers did not get funding because the banks, in their eagerness to avoid defaults by weak borrowers, kept ever-greening. So, poor lending turned into zombie lending distorting markets. Dr Acharya’s prescription was, to “capitalize the banks and lend”. Otherwise, it’s throwing good money after bad.
Indian banking has taken baby steps to turn vibrant and process-driven in the past few years. Be it bankruptcy laws or government’s capital investment in its banks, there’s some semblance of professional action despite an occasional pull to go back to the days of crony capitalism.
Are these good enough for unconventional measures?
Probably, a book by Dr Acharya, a year after he says good bye to Mint Street, may tell you.
