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The fourth chapter of the Economic Survey deals with the RBI’s monetary policy and financial interventions over the last fiscal year. As everyone is aware, the RBI has been lowering the repo rate until it touched 4% at which point it decided to maintain its position. The main reason for doing this was to cheapen the price of credit thereby encouraging borrowing. This has been the approach taken by central banks around the world as a reaction to the depressed economic growth brought about by the pandemic. In order to avoid a long-term recession, governments and central banks have worked hard to increase the amount of liquidity in the economy, and to a reasonable extent, a recession has been avoided. Of course, the economic damage seen over the last two years has by no means been negligible, but it could have been a lot worse if, for example, governments decided on a policy of austerity. 

While the repo rate is the most commonly used tool to increase liquidity in the market, the RBI has a few other methods that it utilises as well. For example, it has spent Rs. 66,000 crores on refinancing operations for a number of financial institutions such as the National Housing Bank (NHB) and the National Bank for Agriculture and Rural Development (NBARD). It has also conducted a ‘special long-term repo operation’ wherein it lent Rs. 10,000 crores to support MSMEs and the unorganised sector at large at the prevailing interest rate of 4%. This means that over the next 3 years, a sum of Rs. 10,000 crores is available to be borrowed at a set rate. The RBI also purchases government securities or G-Secs from the government in order to pump even more money into the economy. Currently, the yield on G-Secs is 6.45%. It reached a record low of 5.75% in June of 2020 in accordance with the need for immediate liquidity. 

Results of the RBI's Efforts

The RBI’s policies have resulted in a liquidity surplus of nearly Rs. 7 lakh crores. This is a steep increase in comparison to September 2021 when the surplus was only a little over Rs. 2 lakh crores. A liquidity surplus occurs when the amount of money going into the banking system is greater than the amount being taken out by the central bank. While there is certainly a need for money in the economy, the RBI must be careful in managing this surplus. At a time when the banking system is riddled with non-performing assets or NPAs (although they have decreased in the last year), it will be important that banks do not lend excessively to non-credible borrowers which will only end up increasing the number of NPAs on their balance sheets. 

Reverse Repo Rate

Data from the survey reveals that the credit has mainly flown to the agricultural sector and to individuals in the form of personal loans. The services sector’s intake of credit has been in decline since the pandemic began with only a small uptick during the latter half of 2021. Industry has also only seen a small increase in recent months. There is a big gap between the amount of credit being utilised by the agricultural and personal loans sectors and that of services and industry and what this tells us is that credit may not be functioning as an effective enough tool to stimulate economic activity. 

Sectoral Credit Growth​

Credit growth in large industries has been much higher than that of medium and small industries where there has been double digit growth in comparison to the year before (48.7% in November 2021 vs 25.7% in November 2020 for medium industries and 12.7% in November 2021 vs 0.6% in November 2020 for micro and small industries). The focus of the government and the RBI throughout the pandemic has been to offer support to businesses that fall under the category of MSMEs as they have also been the most vulnerable during this period. To their credit, this focus has helped ensure that the economy has not plunged into a deeper recession. 

Liquidity Surplus​

Capital Markets

The chapter also takes note of the performance of the country’s stock exchanges in 2021. Nifty grew by 23.79% while the Sensex grew by 21.69%. The year also witnessed the raising of just under Rs. 90,000 crores via the issuing of IPOs, the highest figure seen over the last ten years. The performances of these indices is a reflection of the long-run expectations of investors of corporate India. Much of the positive anticipation is naturally related to the IT sector, which was also primarily responsible for the performance of the IPOs. 

Among 25 emerging market economies, the Indian markets outperformed its peers in the period between April-December 2021. India’s weight as a part of this index (MSCI EM Index which tracks the equity performance of the 25 emerging markets) has increased from 9.25% in December 2020 to 12.45% in December 2021. The survey believes the main reason for this is the governments increase of the foreign portfolio investment (FPI) limit which occurred in May of 2021. 

MSCI EM Index Growth​
Source : RIMES, MSCI, Morgan Stanley Research

The share of individual investors as a percentage of total investors increased from 39% in 2019-20 to 44% in 2021. The main reason for this is the increasing awareness being developed amongst the general public about investing and the stock market. The technological revolution has resulted in the emergence of organisations that have made the various markets more accessible to the average Indian. Simultaneously, the net assets under management within the mutual funds industry rose by 24.4% in 2021 as compared to the year before. 

Challenges Ahead

The RBI and the banking system now have a challenge on their hands. With respect to the RBI, it must find a way to stimulate growth while simultaneously managing inflation. As mentioned previously, injecting surplus liquidity into the economy comes with its own issues. Central banks tend to be better at applying the breaks rather than giving the economy a boost. The banking system, now being in possession of all this money, must be careful to not lend to low-quality borrowers but will also feel pressure from both the government and the RBI to no just sit on all that liquidity for too long as it is the main tool being used to encourage growth. If the market gets flooded with liquidity, then inflation will rise and the profits of banks will be affected. If too much liquidity is withheld, then the recession may be prolonged. It would require deft handling of the situation to see us through the next year or two unscathed. 

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