Home >Industry >Banking >RBI’s band-aid of low repo rate continues

The monetary policy committee of the Reserve Bank of India (RBI) has decided to maintain the repo rate at 4%. Repo rate is the interest at which the RBI lends to the banks and has some influence on the interest at which banks in turn lend to their borrowers.

This RBI believes that the need of the hour is to back growth. At lower interest rates, people will borrow and spend more, and businesses will borrow and expand. The plan is to continue this policy through this financial year and next. The other aim of low interest rates is to help the government continue financing its massive fiscal deficit this year and next, at low interest rates.

While the idea has solid theoretical legs, the non-food credit of banks has risen by just 2.3% between March 27, 2020, and January 21, 2021. Banks give loans to Food Corporation of India and other state procurement agencies to primarily buy rice and wheat directly from farmers. Once these loans are subtracted from overall loans, what remains is non-food credit.

Despite the RBI maintaining the repo rate at 4% since May, below the rate of inflation of 6.6% through this financial year, the lending growth of banks has been slow. Over and above this, the RBI has flooded the financial system with money in different ways.

Along with the fact that bank lending growth has been slow, this flooding of money has led to excess liquidity in the financial system, which as of Thursday stood at 6.71 trillion. This is money that banks currently have no use for. Having said that, it needs to be said that the lending has improved through the months.

What this tells us is that in an environment of economic contraction, there is only so much that the RBI and monetary policy can do. Borrowing and spending will only pick up gradually as people turn more confident about their economic future. Once this happens, companies are likely to borrow and expand, because the ultimate aim of all business expansion is consumption.

An apt 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 band-aid on it.

Further, in a very interesting move, the RBI has proposed to allow 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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