The RBI not only provides money to banks, but also has to supervise them on the issue of liquidity in the economy. Reserve Bank needs to reconcile with holding prices and financing the deficit of the Center at the same time. Both these actions are the mandatory functions of the RBI. While every step of Government resorting to deficit financing by borrowing from the RBI generates additional money supply resulting in inflationary pressures, every step of the RBI is directed towards mitigating the inflation rate.
Govt’s Uncontrolled Overreach
Looking at the deficit figures, it is clear that the Government has, time and again, breached their acceptable limit of deficit financing. This is a violation of the policy discipline of the RBI. The fiscal deficit of the Government is, in fact, a gross intervention in the process of keeping inflation under control.
Caution: The cap on Government Borrowing, enforced by the RBI, has been violated by the Government from time to time. This limit was fixed as a mandatory cap. Today, inflation in India has become a function of Government fiscal deficit. Under the RBI Act, 1948, [the Central Government may from time to time give such direction to the bank as it may, after consultation with the Governor of the Reserve Bank, consider necessary in the public ‘interest’] but it is not mandatory for RBI to provide credit to Government. In the past also, Government did intervene or disrupt the functioning of RBI policy, without regard to the RBI. However, now the frequency of circulars issued by the Government to public sector banks has shown that intervention in the working of the RBI has become more frequent. For instance, the direction by the Government for conversion of banks’ bulk deposits to retail deposit was done to increase liquidity and ease the interest rate. When the proportion of bulk deposits increases in the total deposits of banks, it reduces the buying power of the people and results in lower demand for goods and services, and consequently brings about a reduction in the inflation rate.
Financial Strength:
This expansion of monetary liquidity can nullify the anti-inflationary efforts of the RBI as any increase in money supply causes inflation. On July 31, the central bank did cut the statutory liquidity ratio (SLR) from 24 per cent to 23 per cent, which would surely add to money supply and inflation rate. At the same time, banks have been directed to cut the lending rates on Bank loans. These sops have been given by the RBI under Government pressure. Such directives can expose PSU banks to HIGH RISK. In a layman’s language it is not wise to Buy High Sell Low as it will decrease the intrinsic health of the PSU Banks. The Reserve Bank is responsible for performing the duty of lender of last resort.Supervision of the banking sector by the Reserve Bank is not only to check financial strength and performance of banks but also liquidity, maintenance of monetary ratios and capital ratios such as CRR, SLR, equity ratio and capital adequacy ratio also. The conversion of bulk deposits into retail deposits will hurt the profitability of the banks.
No doubt Nations have to resort to deficit financing to accelerate the development but at the same time we have to assure balance between Deficit, Inflation and the Financial Strength of the Indian Economy. Our Economic Policies need to be evaluated time and again. Don’t permit Profits by MNC’s to be taken out of India, rather the same be reinvested in India. They can enjoy the wealth and relax in India also. We want MNC’s to Grow but not by making us Poor. If the such Profits are ploughed back and invested in India, I do not feel there will be any need for deficit financing or liquidity.
September 23rd, 2021
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