Time for RBI to start unwinding its easy-money pandemic policy

Due to this policy, the balance sheet of RBI has grown by 51.4% in the last two years. It had grown by 26.1% in the previous two years. A large part of this surge is due to the RBI owning 59% more rupee securities than it did two years ago. Rupee securities mainly consist of bonds issued by the government to meet the fiscal deficit. RBI has decided to stop buying bonds for now, but at the same time will be ready to print money and buy bonds as and when the situation demands.

The central bank is printing money from financial institutions and buying these bonds in order to pump more money into the financial system and lower interest rates. With cheap loans available, the hope is that people will borrow and spend more, and businesses will borrow and expand. With this, economic activities will resume. Traditional monetary policy has been run around the world this way since 2008, when the last major financial crisis began.

Also, as the debt manager of the government, the RBI needs to ensure that the Center can borrow at low interest rates. As money printing lowered rates, the central government’s average cost of borrowing in 2020-21 was only 5.8%, the lowest in 17 years. It rose to 6.1% between April and June 2021. This has helped the government, as it needs to borrow almost ₹25 trillion between April 2020 and March 2022.

Still, it may be time for the RBI to start taking a slow walk on its accommodative monetary policy. The government has had to borrow more due to the steep fall in tax collections. But things seem to be changing. The Finance Ministry in a press release on 24 September stated that the gross tax collection for the current financial year was ₹6.46 trillion, which was about 16.8% higher in 2019-20 than during the same period. This is mainly due to large and medium listed corporates earning massive profits by reducing costs. The GST collection has also improved. On the other hand, many micro, small and medium enterprises are in trouble.

Apart from helping the government to borrow at lower interest rates, it was expected that at lower interest rates, both the retail and corporate sectors would borrow more. Several news reports have reported that corporates are repaying the loans. Clearly, overall, they are in no mood to borrow, and it is not interest rates that are holding them back. Where capacity utilization remains low, there is no point for corporates to expand.

Besides, bank retail loan growth is still in single digits. Again, it is not the interest rates that are stopping people from borrowing as much as the RBI would like them to borrow. Their ability to pay the Equated Monthly Installments (EMIs) of repayment is reduced. This can be seen in the fact that between April and August, two-wheeler sales in the country stood at just 4.99 million units, down 38 per cent from 8.04 million units logged during the same period of 2019.

Also, the demand for work under the Mahatma Gandhi National Employment Guarantee Scheme during July to September 2021 was almost the same as between July and September 2020. This shows a clear lack of job opportunities. All this clearly tells us that the economic condition of a large section of the population is not pleasant. These are problems that the RBI cannot do anything about.

Meanwhile, low interest rates have created problems. Economist Madan Sabnavis, writing for Mint Views, has suggested that by lending at current interest rates, banks are misvaluing capital, and this does not reflect the true cost of borrowing.

In addition, low interest rates have a negative impact on consumption for those who depend on interest income to meet their expenses. This is something that the RBI and most economists never talk about.

Finally, low interest rates have sent people looking for higher returns on their investments, taking stock prices to levels never seen before. The problem is that when asset bubbles burst, they usually destabilize the entire financial system.

As Governor Das wrote in the preface to the Financial Stability Report released in January this year: “The relationship between certain sectors of the financial markets and the real economy has been increasing in recent times … Banks and financial intermediaries should be aware of these risks and their spread in an interconnected financial system.” It is one thing to admit a problem and it is quite another to do nothing about it.

Finally, the problem with using citations to justify decisions is that you can always find one. As Mahatma Gandhi once said: “It is unwise to be sure of one’s own wisdom. It is healthy to be reminded that the strongest may be weak and the wisest may make mistakes.” Now when will Governor Das say this?

Vivek Kaul is the author of ‘Bad Money’.