Quantitative easing: Is it a solution for economic crisis due to Covid19

COVID 19 is an unprecedented pandemic in the history of mankind, which affected more than 200 countries since December 2019. It affected nearly 20 lakh people globally with more than one lakh lives lost. Countries across the globe are fighting this pandemic through testing, tracing and treating people and creating awareness about personal hygiene and social distancing. Many countries adopted strategy of partial lockdown to complete lockdown resulting in shutting factories and businesses, suspending flights, stopping trains and restricting mobility of goods and people. Government of India announced complete lockdown since 24 March 2020 and relatively successful in containing spread of COVID 19 till mid of April. But, India’s GDP growth estimates took significant hit. World bank predicts India’s GDP growth to be 1.5% – 2.8 % for the FY 2021, which would be lowest in last three decades and Fitch ratings projects it to be at 2%. While central government and state governments are leaving no stone unturned to handle COVID Crisis situation, both are struggling to mobilise required funds to handle massive needs of the 135 crores population of India.

In the above context, Sri K Chandra Shekar Rao, Chief Minister of Telangana suggested Government of India to explore the option of ‘Quantitative Easing’ to release an amount of nearly Rs 10 lakh crores, which is 5% of 203 lakh crores of Indian GDP. The amount generated through Quantitative Easing will be spent by the governments to handle economic crisis due to COVID 19.

In this article an attempt is made to explain process of Quantitative Easing (QE) along with the advantages and side effects of QE.

What is Quantitative Easing?

Quantitative easing is a monetary policy tool used by Central Banks to buy Government bonds/Corporate bonds to create liquidity in markets and boost economy from recession.

In QE, central banks generate money to purchase bonds from banks, financial institutions and infuse money supply for increased credit activity. Banks and Financial institutions may lend to governments, businesses, individual households at lower interest rates. This results in increased levels of consumption and income. Theoretically, when the economy recovers, Central bank sells the bonds and destroys the cash received. This means in the long term there has been no extra cash created.

In what context QE is used by Central Banks QE is used in prolonged recessionary conditions. Usually, Central banks attempts to revive economy through Monetary policy tools such as lowering Cash Reserve Ratio, Statutory Liquidity Ratio, Banks Rates, Repo rates to infuse more liquidity into the economy. QE is used as a last resort, when no other tools are working to revive economy. QE as a monetary policy tool was used by federal reserve bank during  global financial crisis in 2008 and by European Central Bank during Euro Debt Crisis in 2014.

Advantages of Quantitative Easing

QE boosts economic Growth, preserves industries in recession, maintains existing level of employment, increases consumer confidence and increases exports due to reduction in the value of currency due to increased money supply.

Drawbacks to QE

QE may result in higher inflationary conditions, lowers return on savings due to lower interest rates and makes imports costlier due to reduction in the value of currency due to increased money supply . Finally, it may not be possible for Central banks to sell bonds back, which reduces country’s borrowing ability
What can India do to handle economic crisis due to COVID 19?

RBI may create liquidity with governments and banks by purchasing bonds to revive economy through Quantitative Easing. But QE works only with a coordinated fiscal action and monetary stimulus.

QE does not work, if banks are not ready to lend or businesses are not ready to borrow due to lack of demand or consumer does not spend due to lack of confidence. In spite of RBI lowering interest rates six times in row, economic activity could not rise due to increased levels of bad loans with banks and lower income levels in rural India.

Firstly, policy makers may focus on facilitating state governments or Food Corporation of India to procure agricultural produce from farmers at Minimum Support Price. This ensures better income levels in rural India.

Policy makers may encourage businesses to manufacture or render services which strengthens health care system in India, while giving necessary stimulus packages to other sectors of the industry to maintain current level of employment

Banks should be encouraged to lend for development, production and consumption activities of governments, businesses and households.
Finally, RBI will have to create money through QE to support efforts of the governments in fighting COVID 19 and economic crisis due to COVID 19.