CLAW TUTE ASSIGNMENT

REPORT ON COMPARATIVE ANALYSIS

BETWEEN INFLATION AND BANKING SECTOR
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- By Shweta Singla (22BC506) and Kavya Kharbanda (22BC586)

The global COVID-19 outbreak had a devasta ng economic impact, affec ng all facets of the
financial industry. For financial organisa ons like banks in par cular, the pandemic caused a number
of unique problems. Since underdeveloped countries frequently have less developed financial
market infrastructure, this is probably more severe there. The ques on of how the financial sector
may increase its inven ve capabili es in a developing economy is s ll open. The Indian economy is
cri cally supported by the banking industry.

Objec ve of the Study

This study aims to quan fy the direct effects of a COVID-19 pandemic-related lockdown on financial
ins tu ons. The rapid spread of epidemics like COVID-19 has had a significant impact on its impact
on GDP growth, as shown by the drama c decline in key metrics. Many organisa ons, including the
Interna onal Monetary Fund and World Bank, Central Bank economists, fund managers, and
consultant businesses from various countries have expressed concerns about the damaging effects of
a lockdown on GDP.

Introduc on
A bank is a financial ins tu on whose primary func on is to receive customer deposits and lend
money to businesses, governments, and other organisa ons that require it. People all throughout
the world have faith in banks when it comes to their money. The bank provides its clients with a
range of services, such as loans, debit cards, and credit cards. These services are offered as part of
the bank's ini a ves to boost demand and decrease liquidity through the establishment of a par al
credit guarantee programme, compelling public sector banks to lend more money to NBFCs, and
other similar ac ons.

India’s infla on rate

Infla on as measured by the consumer price index reflects the annual percentage change in the cost
to the average consumer of acquiring a basket of goods and services that may be fixed or changed at
specified intervals, such as yearly. The Laspeyres formula is generally used.
  India infla on rate for 2021 was 5.13%, a 1.49% decline from 2020.

 India infla on rate for 2020 was 6.62%, a 2.89% increase from 2019.

 India infla on rate for 2019 was 3.73%, a 0.21% decline from 2018.

 India infla on rate for 2018 was 3.94%, a 0.61% increase from 2017.

Rela onship between banking sector and infla on rate

The rela onship between the banking sector and infla on rate can be complex and mul faceted.
Here are a few key points to consider:

1. Monetary Policy: Central banks play a crucial role in managing infla on through monetary policy.
They o en use interest rates as a tool to control infla on. When infla on is rising, central banks may
increase interest rates to curb spending and borrowing, which can slow down economic ac vity,
including lending and investment in the banking sector.

2. Borrowing and Lending: Infla on can impact the borrowing and lending ac vi es of banks. During
periods of high infla on, the cost of borrowing tends to increase as interest rates rise. This can
reduce demand for loans and impact the profitability of banks. On the other hand, banks may
increase their lending rates to compensate for the higher cost of funds, poten ally affec ng the
borrowing capacity of individuals and businesses.

3. Asset Quality and Loan Performance: Infla on can affect the asset quality of banks and the
performance of their loan por olios. When infla on rises rapidly, it can erode the value of loans
already issued by banks, par cularly if interest rates are not adjusted accordingly. This can lead to a
higher default risk and a decline in the overall quality of bank assets.

4. Demand for Financial Services: Infla on can influence the demand for various financial services.
For example, during periods of high infla on, individuals may seek to protect their savings from
losing value and opt for investment products that offer higher returns. Banks may respond by
offering different investment op ons or adjus ng their product offerings to meet changing customer
needs.

5. Economic Condi ons: Infla on is o en a reflec on of broader economic condi ons. Higher
infla on can be an indica on of robust economic growth, which can posi vely impact the banking
sector by increasing demand for credit and financial services. However, if infla on becomes
uncontrollable or reaches hyperinfla onary levels, it can lead to economic instability and adversely
affect the banking sector.

It's important to note that the rela onship between the banking sector and infla on rate can vary
across different countries, economies, and me periods. Addi onally, other factors such as
regulatory policies, market compe on, and global economic trends also play significant roles in
shaping this rela onship

Impact of COVID 19 on infla on Rate

The COVID-19 pandemic has had a significant impact on the global economy, including the infla on
rate. Here are some key effects of COVID-19 on infla on:

1. Demand-Side Factors: The pandemic resulted in widespread lockdowns, travel restric ons, and
reduced economic ac vity. This led to a decline in consumer demand for goods and services in many
sectors, which in turn caused a decrease in prices. Reduced consumer spending and lower demand
for goods and services contributed to lower infla on rates in several countries.

2. Supply-Side Disrup ons: COVID-19 disrupted global supply chains, leading to shortages of certain
goods and increased produc on costs. Supply chain disrup ons, such as factory closures,
transporta on constraints, and labor shortages, caused supply bo lenecks and reduced produc on
capacity. These disrup ons, coupled with increased costs, resulted in price increases for some goods
and services, contribu ng to infla onary pressures in specific sectors.

3. Government S mulus Measures: To mi gate the economic impact of the pandemic, governments
around the world implemented various fiscal and monetary s mulus measures. These measures,
such as direct payments, unemployment benefits, and business support programs, injected liquidity
into the economy. Increased government spending and monetary easing can poten ally lead to
infla onary pressures in the medium to long term, depending on the scale and dura on of these
measures.

4. Energy and Commodity Prices: COVID-19 had a significant impact on energy markets and
commodity prices. The decline in global demand for oil and gas due to reduced travel and economic
ac vity led to a sharp drop in oil prices during the early stages of the pandemic. However, as
economies recovered and demand rebounded, energy and commodity prices started to rise again,
contribu ng to infla onary pressures.

5. Exchange Rates: Currency fluctua ons also play a role in infla on rates. The pandemic caused
vola lity in global currency markets as investors reacted to changing economic condi ons. Exchange
rate movements can influence import and export prices, affec ng the overall infla on rate in a
country.

It's important to note that the specific impact of COVID-19 on infla on rates varies across countries
and regions, depending on factors such as the severity of the outbreak, government responses, and
the structure of the economy. Addi onally, the long-term infla onary consequences of the pandemic
will depend on how governments and central banks manage their economic policies in the post-
pandemic recovery phase.

News Highlights

“Na onal Sta s cal Org has projected growth of 7% in the current year & 6.5% for the next year & in
RBI for the next year, we have given 6.4%. The current year's growth will be among the highest in
major economies of the world. Our financial sector remains stable, worst of infla on is behind us &
Indian Rupee has exhibited least vola lity among the pear currencies," Shak kanta Das said while
addressing the 17th KP Hormis Commemora ve Lecture at Kochi.

Das pointed out the resilience of the Indian economy despite global shocks like the Covid-19
pandemic, war in Ukraine, etc.

“Despite the mul & overlapping global shocks to the global economy from COVID-19 Pandemic, the
war in Ukraine, & the synchronized monetary policy ghtening by the central banks across the world,
the Indian economy remains resilient & is expected to be the fastest-growing economy in the world,"
the RBI Governor added.

Understanding post-Covid infla on dynamics

Infla on rose sharply a er the Covid-19 pandemic hit. A large body of empirical evidence documents
that the Phillips curve has fla ened over past decades. This raises the ques on whether the Phillips
curve has recently steepened or if large exogenous demand and supply factors are the key to
understanding post-Covid infla on dynamics. We seek to answer this ques on using a workhorse
macroeconomic model.

Impacted areas

No ma er how much money is deposited, the person knows that the bank is the safest place for it to
be because it has strict security measures in place. Banks also provide a wide range of addi onal
services, such as choices for loans and deposits, fixed deposit plans, debit and credit card services,
and many more.

In India now, there are 33 banks opera ng, with 12 being public sector banks and 21 being private.
The Indian economy depends heavily on the banking sector, which also generates a large number of
jobs. Over the past five years, numerous important performance indicators for India's banks have
been steadily declining.

Mi ga on ways adopted by RBI with respect to infla on rate

Repo Rate – The RBI cut the repo rate by 0.75 percentage points to 4.4. Prior to October this year, the
repo rate was 5.15%.

Reverse Repo – The Fed also announced a 90 basis point (0.90%) cut to the reverse repo rate. Banks
say he deposits an average of Rs 300,000 per day with the RBI. Currently, the reverse repo rate is 4%.

Lending Suspension – The RBI governor also ordered a three-month ban on term loans maturing on
March 1, 2020. This applies to all commercial banks including NBFCs including local, regional and
microfinance ins tu ons, coopera ves, all financial ins tu ons in India and housing and
microfinance.

According to CRR - RBI, the cash reserve ra o will be reduced from 4% to 3%. As of March 23, this
would add about $137 million to the economy.

LTRO – RBI also conducts long-term repo transac ons, making more cash available to banks. Banks
must invest this liquidity in commercial paper, investment grade bonds, and non-conver ble bonds.
Easy Working Capital Financing – Lenders can reassess the borrower's working capital cycle, adjust
margins and recalculate pull power. The Reserve Bank of India also clarified that the move would not
lead to write-downs of assets.

MSF - The percentage of SLR that can be used as a margin of error has been increased to 3% and will
remain at that level un l June 30, 2020. In mes of crisis, the banking system could access an
addi onal $137 billion in liquidity at discounted rates through LAF windows, according to the RBI.

New Liquidity - All announcements will impact around 3.2% of GDP, according to the governor.
According to RBI, the country has received a total liquidity injec on of Rs 2.8 crore, or 1.4% of GDP,
since February 2020.

Result

India's gross domes c product (GDP), which was significantly more nega vely impacted by the Covid-
19 epidemic than many other countries, decreased by 24% in the second quarter of 2020. Despite
claims to the contrary from the central government, there is no evidence that a V-shaped recovery
will take place. The severity of the loss was exacerbated by the government's inappropriate and
backward policy response. "The central government's addi onal fiscal s mulus was just roughly one
percent of GDP.

The government's a empts to assist the vast majority of workers who have lost their employment
and means of support as a result have been tragically insufficient, crea ng economic disparity and
making life more difficult for more people. Because of this, there has been a significant demand
compression that has impacted the supply-side shock caused by the rapid cessa on in economic
ac vity brought on by the virus epidemic and the lockdown response to it. Before the Covid-19 crisis,
the Indian government was already inclined towards monetary tools due to its support of
neoliberalism.

Policymakers have turned to a liquidity injec on monetary boost to assist lessen the destruc ve
effects of the coronavirus on the economy. Except for the small por on of the credit flow that the
liquidity injec on was designed to create that was par ally or completely guaranteed by the
government, the risk associated with providing that credit is to be retained by the banks, par cularly
public sector banks.

The central bank has approved a one- me debt restructuring programme and a suspension on debt
service payments for all borrowers un l December 2020 in order to lessen the effects of defaults. In
the event of a pandemic like the Corona, there may be a greater demand for bank loans, which could
result in a decline in unsecured financing op ons like credit cards and personal loans.

Conclusion

Due to the COVID-19 pandemic's effect on deposits, Indian banks are finding it difficult to pay back
their loans. Despite the RBI's three-month grace period, nonperforming assets (NPA) have grown.
The lockout has made the situa on worse, and public banks may see higher non-performing assets
(NPA), which could result in the sale of shares to private investors and possibly spell the end of the
largely public banking sector.

Sugges ons

Indian banks struggle to repay debts due to COVID-19's impact on deposits. RBI must focus on the
banking system, providing loans for small and medium-sized businesses, and ensuring well-
func oning money and capital markets.

India's government must ensure economic stability to prevent a pandemic. As the central authority
of public banks, the government proposed priva za on to alleviate losses during the pandemic.
Gradually priva zing public banks will allow the government to focus on other factors like
demand/supply, policies, and infla on, leaving the banking sector to private organiza ons.

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