The Reserve Bank of India
(RBI) decided to keep the policy rate unchanged on Friday, extending the low-interest rate regime in the Indian economy.
While this will address growth concerns to some extent, there are two other issues that need attention. First, the transmission has been weak at the longer end and second, plush liquidity is now being linked to supply disruption-led higher inflation.
At the shorter end of the yield curve, perhaps, the rate transmission has happened more than expected. The call money rate has dipped below the reverse repo rate (chart 1). This means that banks can borrow from each other at a rate which is lower than what they earn while the money is parked with the RBI. As a result, short-term borrowing cost has come down.
But long-term rates are stickier. Chart 2 shows how fast the yield on one-year treasury bills
has fallen in comparison to the 10-year government bond. Among the long-term rates, the cost of fresh loans has reduced the least.
This is one reason why lending has not picked up. MSMEs
had lower outstanding loans in August (latest available) than a year ago, reveals chart 3. Only agriculture loans are growing fast.
But to cushion the impact of slowdown and assist faster economic recovery, the RBI has been injecting liquidity in the system. Its forex reserves, for instance, have risen 25 per cent since the beginning of 2020 and reached a level of $575 billion at the end of November, shows chart 4.
This bulge in its assets has been balanced with a rise in currency in circulation on its liabilities, which is closing in on Rs 28 trillion. The banking system also has excess liquidity worth about Rs 6.5 trillion, as seen in chart 5.
Finally, the RBI also monitors the exchange rate that is getting affected by foreign capital flows. With massive inflows in November to the tune of Rs 63,000 crore, the Indian rupee has appreciated to its pre-March levels, chart 6 reveals.