It is difficult to believe now that well into the first two quarters of 2018, the commentary on moves by central banks globally was centered around unwinding the stimulus programme after the global financial crisis and the prospect of more interest rate hikes. It is a measure of the dramatic shift since then, following a deceleration in global growth over the last quarter, that central banks are now adopting a softer stance, a dovish tone. With the spectre of a recession in the Eurozone, the European Central Bank (ECB), which had lowered growth projections for this year sharply from 1.7 per cent to 1.1 per cent, has said that it will keep interest rates low through 2019 and will also launch a series of long-term refinancing operations which will run till March 2021 aimed at preventing a credit squeeze for banks in its jurisdiction. The Bank of England, too, has announced a new liquidity facility under which it offers to lend Euros on a weekly basis to provide extra flexibility and to support markets.
All these indicate the mounting challenges for central banks and the policy ammunition they need to have in their arsenal. In India, the test for its central bank now is ensuring not just adequate liquidity but also lowering of interest rates by banks, most of which are yet to revise their lending rates even after the RBI cut its repo rate by 25 basis points to 6.25 per cent last month. That appears to have been the motive for the RBI to unveil a new $5 billion tool to boost liquidity and to nudge banks to cut rates. What the RBI has proposed is a three-year $5 billion rupee-US dollar swap which would mean the central bank buying upto this amount from the market through an auction and simultaneously selling it back to counterparties effective March 2022. This could fuel rupee liquidity, lead to a lower forward premium and hedging costs for importers with the markets reckoning that it could also help prevent a sharp appreciation of the local currency.
The other liquidity tool employed by the RBI has been in the form of Open Market Operations to the tune of over Rs 2.36 lakh crore in 2018-19 with average daily liquidity being in surplus mode in February. Moral suasion on banks may work only up to a point, but from a transmission and signalling point of view, if banks do not bite this time and cut rates, it could cast a shadow on the RBI, especially with expectations of another rate cut in the upcoming monetary policy review. India’s central bank will have to brace to face new risks.