With this, the strategy of RBI and the government that hinges on corporate borrowing and spending seems to be continuing, even though it is not working and comes at a huge cost to savers. It also shows that RBI is more concerned about the government and the corporates, than the common man.
As RBI governor Shaktikanta Das put it in a statement: “The MPC… decided unanimously to continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of covid-19 on the economy, while ensuring that inflation remains within the target going forward.”
Das further said: “It has also been decided to undertake G-SAP 2.0 in Q2:2021-22 and conduct secondary market purchase operations of ₹1.20 trillion to support the market.”
G-SAP stands for government securities acquisition programme. What Das is saying here is that RBI plans to buy government securities worth ₹1.2 trillion between July and September. This, after RBI had already committed to buy government securities worth ₹1 trillion between April and June.
Government securities are financial securities issued by the government to finance its fiscal deficit, or the difference between what it earns and spends. Banks, insurance companies, mutual funds, other financial institutions and corporate treasures, typically buy these securities.
The question is where RBI gets money to buy these securities from. It basically prints this money (or actually simply creates it digitally these days). Hence, between April and September this year, RBI has plans of printing ₹2.2 trillion and buying government securities.
There are two aims behind printing money and buying government securities.
The first is to help the government finance its fiscal deficit, albeit indirectly. Since 1997, RBI is not allowed to print money and hand it over directly to the government to spend. But nothing can stop it from doing that indirectly.
When RBI prints money and buys bonds, the supply of money in the financial system goes up. And given that, banks, insurance companies, mutual funds, other financial institutions and corporate treasures, can use this ‘new’ money to buy government securities.
So, printing money helps the government in this way, especially during times when tax collections are likely to slow down. The government is expected to borrow ₹12.1 trillion during the course of this financial year.
Also, printing money ensures that there is enough money going around in the financial system and in the process, interest rates continue to remain low. This allows the government to borrow at low rates.
This is as conventional as central bank monetary policy can get. If the interest rates at which the government borrows are low, the interest rates for others are also low, though not as low as the government. This is primarily because lending to the government is deemed to be the safest form of lending.
The idea is that at lower interest rates, corporates will borrow and expand, and people will borrow and spend. This will lead to an economic revival.
The trouble is that it takes more than just low interest rates for the corporates to borrow and expand. Between May 2016 and April 2021, the weighted average lending rate on fresh rupee loans of banks, fell from 10.61% to 8.1%.
During the same period, outstanding bank lending to industry has barely moved up from ₹26.63 trillion to ₹28.96 trillion, at the rate of 1.7% per year. Clearly, corporates do not borrow and expand just because interest rates are low. They need to be confident about the fact there will be an adequate demand for the stuff they will make, after borrowing and expanding. That confidence has been missing, over the last few years.
Of course, this aim of encouraging corporates has come at the cost of savers. The interest rate on one-year fixed deposits is now down to as low as 5%. The real rate of return after adjusting for inflation and the tax to be paid on interest earned, has been in negative territory for a while.
What does not help is the fact that inflation is likely to continue to go up primarily because as the global economy recovers after covid, demand for things will keep going up, pushing up prices.
With the aim of encouraging corporates to borrow likely to continue in the months to come, interest rates will continue to remain low. Hence, real returns on deposits will continue to remain in negative territory.
Of course, this is likely to lead to some money continuing to move into stocks, cryptos, etc., in the hope of earning a higher return. As the The RBI Annual Report points out: “Liquidity injected to support economic recovery [read money printing] can lead to unintended consequences in the form of inflationary asset prices [stock market rising].”
The unintended consequences notwithstanding, there is no free lunch in economics. The savers are already paying for this. It is worth remembering here that in many rich countries, the monetary policy of keeping interest rates low has worked to some extent, primarily because it has been accompanied by some fiscal policy as well, where the government has put money directly into the hands of people. That bit is missing in India, given that the hand of the Indian government is limited on this front.
Plus, with stock prices beyond what corporate earnings truly justify, the risk in the entire financial system has gone up.
The trouble is that the RBI-government formula of getting the corporates to borrow and spend, or simply spend for that matter, isn’t really working. The investment to GDP ratio was at a two-decade low in 2020-21.
Corporate tax collections in 2020-21 were lower than income tax collections for the first time in many years. This, despite the fact that the profits of listed corporates were at an all-time high level in absolute terms. This was primarily on account of the base corporate tax rate being cut in September 2019 to 22%, from the earlier 30%.
But given that both the government and RBI seem to be persisting with the formula, they appear to have clearly run out of ideas.
Vivek Kaul is the author of Bad Money.
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