By Robert Elway
Since the new currency notes were released in the market after demonetisation, it has had a significant effect on the economy as is evident from the rise in bank reserves, which in turn increases lending to consumers and business houses. If this lending can be sustained, it can lead to more jobs and an increased spending by farmers which can bolster crop yields and thereby contribute to maintaining affordable food prices.
Nevertheless, consumers may still find it difficult to strike a good deal on loans for cars and houses, two goods which are being increasingly demanded by India’s growing middle class. This is because the Reserve Bank of India (RBI) is keeping an eye on the amount of money in circulation and is also making efforts this month to reduce the money supply. Another indicator of a growing middle class is the rising demand for gold. Even during periods of a major price increase in gold, demand usually increases in India when consumers? incomes are rising and it is expected to recover this year.
Dynamics of the market for gold
According to a recent report issued by the World Gold Council, the demand for gold in India dropped to its lowest level last year, since 2009, due to the removal of the Rs 500 and Rs 1000 currency notes. Demand is likely to recover, however, as liquidity improves in the banking system which goes to show how the cycle of lending and credit can even affect a precious metal that only derives 10% of its demand from investments and finance.
Long-term loan growth may not improve given the fact that the RBI is committed to easing off accommodation and adopting a more neutral stance. The RBI said in its last statement in February that it was targeting 5% inflation by the end of 2017. This target is for the Consumer Price Index (CPI), which measures the price consumers pay for a basket of goods and services selected to represent the overall price growth in the economy.
The effects of monetary policy
For consumers and businesses, lower money supply can mean less opportunity to take out new loans or higher borrowing costs on loans overall. The RBI had left rates unchanged in February and it did the same by leaving the repo rate at 6.25% as of Thursday, April 6.
The repo rate is the rate at which the RBI lends money to the commercial banks. Thus, the higher the repo rate, the less money commercial banks have in circulation. This is because they have to pay the Reserve Bank of India more money on the debt they owe.
However, the RBI both lends and borrows money from commercial banks. Just as the repo rate is the rate that the RBI charges, the reverse repo rate is the percentage that the RBI pays to borrow from these banks. As with the repo rate, the money supply decreases if the reverse repo rate increases since banks keep excess reserves with the RBI instead of lending it out to consumers.
On April 6, the RBI increased the reverse repo rate despite keeping the repo rate unchanged. This could result in lower money supply since the RBI is now paying 6% on its debts held by commercial banks. Compared to last month, this is 0.25% points higher, and the next decision is slated for June.
Robert Elway?is a Senior Account Representative at Rosland Capital.
Featured Image Source: livemint
