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Another big part of the  ₹20 trillion package was an extraordinary liquidity injection by RBI to the tune of  ₹8 trillion.
Another big part of the 20 trillion package was an extraordinary liquidity injection by RBI to the tune of 8 trillion.

Loose monetary policy is worsening wealth inequality

  • The MSME loan guarantee is aimed at relatively better off firms that had a good credit standing in March

The size of the Atmanirbhar Bharat package announced by Prime Minister Narendra Modi in May was estimated to be about 20 trillion, or nearly 10% of gross domestic product (GDP). This was a relief package to combat the economic crisis caused by the covid pandemic. On closer inspection of its components, it emerged that nearly 90% was in the form of liquidity or loan support. For instance, it included collateral free loans to micro, small and medium enterprises (MSMEs) worth 3 trillion, which would be guaranteed by the central government. The loans themselves would be given by commercial banks based on liquidity support from the Reserve Bank of India (RBI). Thus, the actual payout from the Centre’s treasury, or the fiscal resources that would flow out, would only occur in cases of delinquency on these loans, which were presumably at least four years away. Only about a fifth of those advances are expected to have their guarantees invoked, notwithstanding the worrying delinquency data on Mudra loans. Even with such a generous offer, the actual offtake five months after the announcement is not even 60%. It should have been gobbled up immediately. Contrast this with the furlough scheme announced by the UK government, which was snapped up by nearly 70% of British firms soon after its debut in March. That scheme involved an actual fiscal outflow from the treasury, unlike India’s credit guarantee scheme. The MSME loan guarantee is aimed at relatively better off firms that had a good credit standing in March.

No wonder the offtake is less than enthusiastic, since a firm with a poor business outlook is unlikely to take on a new loan burden, however generous the payment terms may be. Another big part of the 20 trillion package was an extraordinary liquidity injection by RBI to the tune of 8 trillion. This was a combination of long-term repo operations (LTRO), targeted LTRO and specific liquidity support for mutual funds, as also open market purchases of bonds. Cheap LTRO funds were made available to banks for three years (instead of overnight), in anticipation of these being lent to needy borrowers. But despite such heroic liquidity support, credit growth has been lukewarm. Instead, there has been refinancing of existing term loans, to the clear benefit of large borrowers that get to reduce their overall funding cost. Such savings directly lift bottom lines. This is an example of liquidity support sharpening the skew between bigger and well-capitalized firms and smaller MSMEs facing extinction.

This is a broader thesis of the impact of ultra-loose monetary policy seen in developed economies since the global crisis of 2008-09. Interest rates, whether in the US, European Union or Japan, have been held close to zero with almost unlimited monetary easing (i.e. the printing of money). The balance sheet of the US Federal Reserve grew 400% in the 10 years prior to the pandemic, and has grown further from $4 trillion to $7 trillion since March. The European Central Bank too is pursuing unconventional monetary easing, involving even buying private-sector junk bonds. Despite such massive easing, we don’t see much impact on economic growth or a decrease in unemployment, nor do we see a flare-up of inflation. Instead, we see extreme bullishness in financial markets, causing a simultaneous rally in stocks, bonds, precious metals and sundry commodities like base metals. Even in the four years before the pandemic, corporations in America, high on profits thanks to the tax cuts, were spending $1 trillion every year to buy back their own stock. This is highly correlated to the rise of stock prices and indices, which in turn is good for year-end bonuses. But within the index rally lay hidden an ugly skew. The market value of the top five stocks in the S&P 500 index is equal to the bottom 300, showing an unequal distribution of financial wealth even among the top 500 stocks.

During this pandemic year, with most of the world in a recession, J.P. Morgan Chase has reported a 54% rise in fixed income revenues, mainly from bond trading. Citigroup’s surge in similar income is 42%. The rise in income from stock and equity underwriting is no less spectacular. Of course, banks will probably suffer some losses in conventional lending activity, or at least their provisioning will have to rise, as the pandemic results in higher than usual bankruptcies.

Thus, a loose monetary policy that seeks to revive the economy is instead worsening wealth inequality. Since stocks, bonds and other financial-asset ownership tends to be in the higher income deciles, the gains accrue at the higher end. This means that even income inequality is worsening. This is in stark contrast with fiscal policy, which can directly inject cash into low income deciles, or lead to job creation through government spending on infrastructure or on rural and urban jobs schemes. This, of course, has to come from the overall tax kitty. It may be an opportune time to explore how stock market wealth could be tapped for some fiscal resources now. The money could be used for explicit redistributive relief (see my Mint column, Tap Stock Market Wealth for a Stimulus Programme, 24 August 2020). In any case, banks that face mounting non-performing loans on account of pandemic-pushed bankruptcies would need to be bailed out with taxpayer-funded capital. It is unlikely that liquidity support alone can provide India’s economy a growth impetus. We need a fiscal stimulus. It would be more effective and less inequality-causing.

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