What Is Financial Repression?

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SLR or the requirement of banks to hold certain part of assets in liquid forms is essential to efficient banking and is instrumental in meeting any unexpected demand from depositors. The rate which was hitherto 38% before 1991 reforms has been revised to 21.5% in February 2015. Implementation of financial repression policies also leads to higher inflation expectation. Higher inflation subsequently leads to a rise in bond yields — a regime in which growth stocks and bonds would under-perform.

The deregulation of financial markets spurred monetary growth in the giant industrialised economies. The main repressive policies underneath Bretton Woods had been a relic from the inter-warfare period. financial repression upsc Monetary stimulus is more nuanced; like pushing on a string, the certainty of success is low, and the consequences of negative real interest rates are far-reaching (particularly in the money market).

Financial repression

In addition, previously feared but now tamed private market bond vigilantes like PIMCO have similar choices, if clients with their index-bounded holdings begin to broaden their guidelines. Third, during covid, banks in the developed world were encouraged to lend despite lockdown-led recessions. In India, broad money growth returned to its pre-covid level in February 2022, while in the developed world, it remains above its pre-covid levels. India’s low debt-to-GDP ratio suggests it has greater policy flexibility, and the trends in broad money growth suggest that local policymakers are taking advantage of this flexibility. This is done by keeping interest rate levels below that of inflation, effectively taxing the country’s savers. The upside is that cheap loans and credit products become available to borrow, which can lead to economic growth.

Within a month, the threat of a domino effect through the global financial system forced western governments to inject vast sums of capital into their banks to prevent them collapsing. Credit flows to the private sector were choked off at the same time as consumer and business confidence collapsed. All this came after a period when high oil prices had persuaded central banks that the priority was to keep interest rates high as a bulwark against inflation rather than to cut them in anticipation of the financial crisis spreading to the real economy. With public and private external debts at document highs, many advanced economies are increasingly wanting inward for public debt placements. At the end of 2013 the true yields that the UK government had to pay on its debt have been negative over the whole curve. Several possible explanations are available for this phenomenon – central financial institution action, regulatory modifications, demographic developments and financial circumstances.

What is Long Term Repo Operations (LTROs)?

Banks can effectively offer massive loans to these unprofitable companies, allowing them to continue operating. In the present context, high SLR and priority sector norms and rising NPAs are chains on the hands of the banking system and they constitute financial repression on the asset side. The purpose of financial repression is to keep interest cost low and inflate the economy. It is good for the government as they borrow cheap and the debt-to-GDP ratio looks more reasonable, but it hurts savers.

• The restrictions or regulatory measures of that era had their origins in what would now come underneath the heading of ‘macroprudential’ considerations in the wake of the extreme banking crises that swept many nations in the early Nineteen Thirties.
• Financial repression sparked spectacular economic progress and made the compensation of war debt primarily painless.
• Together, there is the potential for both public and private market creditors to effect a change in how credit is funded and dispersed – our global monetary system.
• That presupposes that yields will not rise (causing prices to fall, incurring a loss of principle).

As it is onerous to hide such costs, this appears to be the least engaging choice for policymakers. Second, the monetary sector gains relative to the rest of the financial system as a result of foreign money units newly issued by the central bank are transferred first to the financial establishments, which may spend the newly issued forex units first. Each beforehand created forex unit held by different economic brokers can purchase a smaller portion of goods, providers, or assets (corresponding to shares and real estate) (Cantillon 1931). Reinhart and Sbrancia argue on the premise of historical expertise that low nominal interest rates help to include debt servicing prices and to reduce the true worth of presidency debt. Thus, monetary repression is seen as a pre-step for the exit from excessive financial growth.

India’s structural opportunity in a new age of financial repression

The massive flow of savings from the surplus countries to the deficit countries lowered global interest rates by encouraging reckless investment into risky housing-related assets such as subprime mortgages. Apart from this, loose monetary policy in the U.S left the banks with a decrease in net interest margins for the banks, decreasing their profits. The bloated financial sector, flawed belief in efficient markets, greedy bankers, incompetent rating agencies are considered to be some of the other causes for the financial crisis.

These include pensioners, retired people, university endowments, sovereign wealth funds, insurance companies, and anyone that has a need for low volatility, liquid assets and/or considerable cash on hand. Some funds, realizing the negative real yields of treasuries, gilts, bunds, etc., have been diversifying into land, dividend-paying equities, and commodities. So long as the negative real returns on loans exist, lending to massive, lethargic state enterprises can continue. This credit abnormality is most effective when there are medium to high levels of inflation.

When the Rupee will become an international currency like the US…

However, failure of regulation on the banks’ parts was one of the major reasons behind the crisis. Banks were allowed extraordinarily high levels of debt in relation to equity capital. Also, investment by banks in the advanced economies in complex assets called “securitised” assets (securities derived from sub-prime loans or the housing loans of relatively higher risk) added to the vulnerability of the financial infrastructure. Further, the failure of banking systems around the world was aggravated by the by fiscal and monetary expansion. The monetary repression “tax rate” is significantly larger in years of exchange controls and legislated rate of interest ceilings.

However, in the 1960s, Japan and a few small tiger states (Hong Kong, Singapore, Taiwan) supplied evidence that opening up markets was a supply of prosperity. “May you live in interesting times” happens to be considered a curse in Chinese culture… best of luck. A banking collapse is admittedly different from, say, Pets.com or Blockbuster going under, but moral hazard remains. The dollar swap lines that the Fed opened to European banks in November 2011 might also be included. In a statement in July, the Fed considered lowering interest paid on bank reserves (below 25 basis points), even after Bernanke suggested it was too drastic in February. In order to accommodate a steadily rising standard of living (“American Dream”), consumers bought on credit.

Experience suggests, that the industrial banking system will set the tempo because of their principal function of credit creation. Other than bank deposits, savers do not have many options because of capital controls and restrictions on buying foreign assets. Banks tried using other options, such as life insurance products that have higher yields, to attract savers. Even though this seems to be a more appealing choice, when taking inflation into account, the overall return is negative. Often higher inflation discourages savings or deposits as the real rate of interest is low or negative (During high inflation, rate of interest by banks seems to be little as value of money falls greater and people may turn to physical assets like gold). Hence the government has to settle the asset side which is created out of its own policies.

Reinhart and Sbrancia present that many countries had a interval of abnormally low actual rates of interest – compared with the interval before the wars and after the 1980s. This decoupling between rates of interest and threat is a common function of financially repressed systems. We additionally discover that, after controlling for policies of monetary repression, a regional dummy for Latin America in growth regressions tends to be insignificant. The global growth outlook has collapsed, and the depth and speed of the collapse is worse than the Global Financial Crisis (GFC) of 2008.

Second, Indian policymakers should partially protect the economy from the pro-inflation policies of the developed world’s repressionary monetary system. From the chart below, you can see that Chinese banks have higher profitability margins than their western counterparts on a continual basis. Financial repression is also useful for governments to control capital and have its citizens consume the bulk of domestic government debt. Double financial repression was pointed out in Economic Survey of FY15 by economist Arvind Subramanian. It referred to a phenomenon where the Indian banks suffered financial repression both on the assets and liabilities side.

This has had a direct effect on real interest rates and hence reduction in household savings as people have to spend more on daily food items. The inflation has eased over the years and the liability side recession has also come down considerably. High inflation and reduced return on assets of banks has further strengthened the fact that rates maintained by banks did not give a positive rate of return on deposits to households. Since March 2020, central banks have been taking decisive actions to reduce interest rates, which has led to a decline in bond yields. It is a policy of the central bank and government of very low interest rate for the purpose of providing cheap loans to the government and ‘inflate’ government debt. By inflating the government debt, the value of debt would become a lot less in the future because of the impact of inflation.

The high and chronic ranges of unemployment in many advanced economies in the wake of the disaster add further motivation for central banks to maintain rates of interest low. Yet, policy makers in African LDCs have failed to comply with an active policy of creating the domestic monetary and monetary sector. The same paper found that financial repression was a key element in explaining periods of time where advanced economies were able to reduce their public debt at a relatively quick pace. More recently, public debts have grown as a result of stimulus programs designed to help lift economies out of the Great Recession. Financial repression is a term used to describe a policy environment where central banks and governments deliberately keep interest rates below the rate of inflation.