RBI’s Band-Aid on Low Repo Rate Continues
The Monetary Policy Committee of the Reserve Bank of India (RBI) decided to keep the repo rate at 4%. Pension rate is the interest rate at which the RBI lends to banks and has some influence on the interest rate at which banks in turn lend to their borrowers.
This RBI believes that the need of the hour is to support growth. At lower interest rates, people will borrow and spend more, and businesses will borrow and grow. The plan is to continue this policy in this fiscal year and the next. The other goal of low interest rates is to help the government continue to finance its huge public deficit this year and next, at low interest rates.
Although the idea has solid theoretical foundations, banks’ non-food credit only increased by 2.3% between March 27, 2020 and January 21, 2021. Banks provide loans to the Food Corporation of India and to other state supply agencies to purchase mainly rice. and wheat directly from farmers. Once these loans are subtracted from the total loans, only the non-food credit remains.
Although the RBI has kept the repo rate at 4% since May, below the 6.6% inflation rate throughout this fiscal year, bank lending growth has been slow. On top of that, the RBI has flooded the financial system with money in various ways.
In addition to slowing the growth of bank credit, this influx of money led to excess liquidity in the financial system, which amounted to Thursday at ₹6.71 trillion. It is money that banks currently have no use for. Having said that, it must be said that the loans have improved over the months.
What this tells us is that in an environment of economic contraction there is little that the RBI and monetary policy can do. Borrowing and spending will only pick up gradually as people gain more confidence in their economic future. Once this happens, businesses are likely to borrow and grow, as the ultimate goal of any business expansion is consumption.
A proper comparison here would be to compare the current economic contraction and lack of economic confidence to a deep wound in the human body, which can only gradually heal itself. The RBI can only apply a bandage to it.
Additionally, in a very interesting move, the RBI has proposed allowing retail investors to buy government bonds directly online through the facility called Reserve Bank (Retail Direct).
Vivek Kaul is the author of Bad Money.
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