At a meeting last week, the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) decided to maintain its accommodative monetary policy “as long as necessary.” says “to lose patience is to lose the battle”. Therefore, the easy money policy triggered by the RBI to lower interest rates will continue.
As a result of this policy, RBI’s balance sheet has grown 51.4% over the past two years. In the previous two years, it had increased by 26.1%. Much of this jump is due to the fact that RBI owns 59% more securities in rupees than two years ago. Rupee securities mainly include bonds issued by the government to finance the budget deficit. RBI has decided to stop buying bonds from now on, but will at the same time remain ready to print money and buy bonds if the situation calls for it.
The central bank printed money and bought these bonds from financial institutions to pump more money into the financial system and lower interest rates. With cheaper loans available, the hope is that people borrow and spend more, and that businesses borrow and grow. This will revive economic activity. This is how conventional monetary policy has been conducted around the world since 2008, when the last major financial crisis erupted.
In addition, as the manager of the government’s debt, the RBI must ensure that the Center can borrow at low interest rates. While money printing pushed rates down, the central government’s average cost of borrowing in 2020-2021 was just 5.8%, the lowest in 17 years. This rate rose to 6.1% between April and June 2021. This has helped the government, given that it needs to borrow close to ??25 trillion between April 2020 and March 2022.
Nonetheless, it may be time for the RBI to slow its accommodative monetary policy. The government had to borrow more due to a massive drop in tax revenue. But things seem to be changing. The Ministry of Finance in a September 24 statement pointed out that gross tax revenue for the current fiscal year amounted to ??6.46 trillion, about 16.8% more than during the same period in 2019-2020. This is mainly due to the fact that large and medium listed companies have made huge profits by reducing their costs. GST collections have also improved. On the other hand, many micro, small and medium enterprises continue to be in difficulty.
In addition to helping the government borrow at lower interest rates, the hope was that at lower interest rates, the retail and corporate sectors would borrow more. Several press articles pointed out that companies were repaying their loans. Clearly, overall, they’re not in the mood to borrow, and it’s not the interest rates holding them back. Where capacity utilization remains low, it does not make sense for businesses to expand.
In addition, the growth of personal bank loans is still in single digits. Again, it’s not the interest rates that keep people from borrowing as much as the RBI would like them to borrow. Their ability to pay Equal Monthly Installments (EMIs) of repayment has diminished. This can be seen in the fact that sales of two-wheelers in the country between April and August amounted to just 4.99 million units, down 38% from the 8.04 million units recorded. during the same period of 2019.
In addition, the demand for work under Mahatma Gandhi’s National Employment Guarantee Program from July to September 2021 was almost similar to that from July to September 2020. This reveals a clear lack of employment opportunities. All of this clearly tells us that the economic situation of a large part of the population is not encouraging. These are issues that RBI cannot do anything about.
Meanwhile, low interest rates have created problems. Economist Madan Sabnavis, writing for Mint Views, suggested that by lending at the interest rates they currently are, banks misjudge capital, and this does not reflect the true cost of the loan.
In addition, low interest rates have a negative impact on the consumption of those who depend on interest income to meet their expenses. This is something that RBI and most economists never seem to talk about.
Finally, falling interest rates have caused people to seek higher returns on their investments, pushing stock prices to levels never seen before. The problem is, when asset bubbles burst, they usually destabilize the entire financial system.
As Governor Das wrote in the foreword to the Financial Stability Report published in January of this year: “The disconnection between certain segments of the financial markets and the real economy has become more pronounced in recent times… Strained valuations of financial assets pose risks to financial stability. Banks and financial intermediaries need to be aware of these risks and spillovers in an interconnected financial system. It’s one thing to recognize a problem and quite another to do nothing.
Finally, the problem with using quotes to justify decisions is that you can always find one. As Mahatma Gandhi once said: “It is not wise to be too sure of your own wisdom. It is healthy to remember that the stronger can be weak and the wiser can be wrong. Now when will Governor Das say that?
Vivek Kaul is the author of “Bad Money”.
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