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HomeEconomyRBI shouldn't emulate US Fed to fight COVID-19, SBI reasons

RBI shouldn’t emulate US Fed to fight COVID-19, SBI reasons

The share of retail investor participant as a proportion to total investors is only 11% in India while the same is close to 50% in the US

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The economic loss arising out of the coronavirus 2019 (COVID-19) is expected to exceed the worst figures of $ 40 billion estimated for SARS 2003 and could be at $ 46 billion, believes the State Bank of India (SBI) in an analysis authored by its Group Chief Economic Adviser Soumya Kanti Ghosh. In view of this worrisome development, should the Reserve Bank of India (RBI) follow what the US Federal Reserve did on 3 March, cutting its lending rate drastically as it had done during the 2008 subprime mortgage crisis?

The novel COVID-19 outbreak has spread rapidly across 84 countries. There are currently 95,488 confirmed cases and 3,286 deaths from the coronavirus COVID-19 outbreak as of 5 March. The cases of death are spreading also across the countries led by China (3013), followed by Italy (107) and Iran (92), either ageing economies and/ or having significantly lower temperatures or both. In India, 30 cases have been found, of which 3 have recovered. Compared to the outbreak of SARS coronavirus 2003, the proportion of damage done by COVID-19 is expected to be much greater.

Since the outbreak of SARS 2003 virus, the policy response to containing such risk has evolved considerably. However, interactions between economic model and models of epidemiology are not well understood due to deep uncertainty about these phenomena. As a result, the impact of epidemics has been considerably under-researched in economics and there is no theoretical framework giving a precise ordering of whether monetary policy will be more potent than fiscal policy though the outbreak will have erosion of demand due to adverse labour market outcome on account of morbidity and mortality.

However, there is also an embedded adverse supply shock angle as China is the supplier of many critical inputs in the global supply chain of manufacturing. In this respect, a (possible) shock is not comparable to other types of crisis. Hence, only a rate cut by the RBI in the current situation will lead to an asset bubble and possibly no correction in demand.

Interestingly, monetary policy actions like rate cuts in developed countries are for a particular reason. Since the early 1980s, the behaviour of asset prices has posed a continuing concern to central banks in developed economies in their formation of monetary policy. This dichotomy of protecting the ‘wealth effect’ and become accommodative to growth poses a huge challenge to the central bank in developed markets and, hence, the coordinated rate cuts.

However, the share of retail investor participant as a proportion to total investors is only 11% in India while the same is close to 50% in the US, 42% in Italy and 20% in Singapore. If this is so, we believe in the current COVID-19 outbreak, a conventional monetary policy like rate cuts by the RBI might be the second-best option. The best option will be still maintaining a proactive liquidity regime and facilitating stability in financial markets through unconventional measures.

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