Only a rate cut in the current situation will only lead to asset bubbles and possibly no correction in demand.
As the coronavirus outbreak has slowed down the economies worldwide, the central banks of many nations, including India, are thinking of an interest rate cut as a potential option to boost demand. However, there is a deep uncertainty on the relation of the economic models and models of epidemiology. This makes it difficult to make a precise decision about whether monetary policy will be more potent than fiscal policy, according to the SBI Ecowrap report. On top of it, the adverse supply shock from China has also made a big difference as the country is a major supplier of many critical inputs in the global supply chain of manufacturing. In this respect, the conditions are not comparable to other types of crisis, hence, a mere rate cut in the current situation will only lead to asset bubbles and possibly no correction in demand, the report added.
The SBI report said that a cut in rate can be effective but maintaining a proactive liquidity regime and facilitating stability in financial markets through unconventional measures will be much more important. The report also said that they rather believe the arguments of RBI cutting rates have more to do with coordinated policy actions by the central banks and they are surprised why despite high inflation and low-interest rates in India, the premature RBI rate cut is gaining precedence.
Even the economic loss arising out of the outbreak is expected to reach an unprecedented level. The economic loss at the time of the SARS outbreak was $40 billion, which is estimated at $46 billion now. Meanwhile, the US Fed Reserve cut interest rates by 50 basis points amid coronavirus fears. “The spread of coronavirus has brought new challenges and risks to the financial market and the magnitude and persistence of the overall effect on the economy remain highly uncertain,” aid Federal Reserve Chair Jerome Powell.