Why is India Following a Loose Monetary Policy?

Ever since the great recession ended in 2009, the entire world has been following loose expansionist monetary policies. However, after a decade of such policies, most countries in the world have now started resorting to monetary tightening. The Federal Reserve has raised interest rates four consecutive times in the past four years. The Reserve Bank of India was also raising its interest rates. However, recently the bank has suddenly changed course. It is now reverting to a lot of loose monetary policies. These decisions are inviting a lot of criticism from critics. Loose monetary policies are required to revamp a failing economy. However, since the Indian economy is already doing well, such policies are likely to cause overheating.

In this article, we will have a closer look at some of the loose monetary policies which are being followed by the Indian government as well as its economic effects.

Policy Changes By The Reserve Bank of India

The Reserve Bank of India has made some drastic and unexpected changes to the monetary policy. These changes are aimed at creating more credit which leads to a boom in the underlying economy.

  • Firstly, the Reserve Bank of India has reduced the interest rates by 250 basis points. Also, it has changed the stance from calibrated tightening to neutral. This change in stance paves the way for more interest rates reduction in the future. The Reserve Bank also wants to ensure that the benefits of these rate hikes are passed on to the consumer. This is the reason that they have warned banks to pass on the rate hikes so that the underlying objectives of the Reserve Bank are achieved.
  • Secondly, the Reserve Bank of India has allowed banks to use their bond holdings for liquidity coverage. This move is expected to increase the liquidity in the system by over 2 lakh crores. RBI has made this move since it wants the banks to increase lending which would increase the growth rate.
  • Thirdly, the Reserve Bank of India is creating new securitization norms for the banks who give housing loans. This move is also likely to release a tsunami of funds in the market. Active secondary markets would free up around 60,000 crores for more lending. The Indian real estate sector is in dire need of funds. The Non-Banking Finance Companies which used to lend extensively to the real estate sector are facing a crisis of their own. Hence, funds are in short supply and securitization seems to be a viable option.

However, securitization is a controversial financial practice since it was at the heart of recession which happened in America in 2009. The Reserve Bank of India is supposedly improving the securitization practice so that the liquidity in the market can be increased without actually increasing the risk.

From all the above policies it is obvious that the Reserve Bank is trying to quickly increase the growth rate of the economy. However, the question arises why is the RBI doing so?

Lower Inflation

The RBI is justifying all these policy changes on the back of lower inflation recorded. However, this argument stands on very shaky grounds. Most of the reduction in the inflation rate has been caused by a drop in fuel prices. Fuel prices are very volatile. Just about six months back, fuel prices were reaching an all-time high. If the prices of crude in the international market rise, these prices will once again start increasing in no time. The Reserve Bank of India is making semi-permanent decisions based on factors which could literally change overnight!

Realty Sector

Arun Jaitley, who is the Finance Minister of India, has mentioned that the government intends to keep lowering the interest rates in the future. This will be done in order to ensure an increase in the growth rate of the real estate sector. The Indian real estate sector is at an all-time low. Consumers are not buying any houses because the prices are too high. The Finance minister has announced that he intends to bring down the prices so drastically that the mortgage payment on a housing loan as well as the rent will be equivalent. At the present moment, the rent is only 25% of the mortgage payment.

Political Gimmicks

Lastly, it is widely believed that the interest rates have been lowered to provide benefits to the incumbent government during the national election. It seems like the government is purposely trying to loosen the monetary policy. This will help them create an aura of financial well-being. At the present moment, the Indian stock markets are at an all-time high, interest rates are low, and the economy appears to be booming. The government wants to create an illusion of prosperity to gain votes even though these policies may not be beneficial for the nation in the long run.

The bottom line is that the policies of the Indian government appear to be strange and misplaced when the global economic climate is considered. However, these policies make a lot more sense when local political motives are understood.

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