The Economic Survey on India’s Monetary Situation in 2020

The Economic Survey of India (ESI) 2021 was published on 29th January 2021, three days before the Union budget 2021-22 presented on 1st February 2021. This is a report on the state of the Indian economy published by the Ministry of Finance as a precursor to presenting the proposed future path for the economy in the budget. The Survey is written by a team led by the Chief Economic Advisor (CEA) of the Government of India. The CEA is the head of the Economic Division within the Department of Economic Affairs at the Ministry of Finance. While the government has multiple economic advisors and advisory councils, the CEA is the highest economic advisor of the Indian government. Nonetheless, the former CEA Arvind Subramaniam had opined in his book that the CEA’s only job is to write the Economic Survey; the government is not bound to seek the advice of the CEA on other economic decisions or follow the recommendations of CEA on any decisions.

The survey this year was prepared under the leadership of Dr. Krishnamurty Subramanian, our current CEA. Chapter 4 in Volume 2 of the survey titled ‘ Monetary Management and Financial Intermediation’ has dedicated a few pages to describe the monetary situation in the country. In this article, I present a summary of three developments in 2020 pertaining to the monetary situation in the country detailed in ESI 2021; interest rates, bond yields and liquidity.

Unprecedented changes in policy rate

The money supply in the economy is controlled by the central bank by altering the interest rates in the country. It does so by changing the repo rate (aka the policy rate), a rate at which Reserve Bank of India lends money to commercial banks. Since 2016, the authority to set these rates is vested in the Monetary Policy Committee. The 6 person committe chaired by the RBI Governor consists of two more members from the RBI and three external member (usually academicians).

As is outlined in the ESI, the committee cut the repo rate by 0.75% and 0.4% and the reverse repo by in its two consecutive meetings in March and May 2020 and have kept the rates unchanged since May 2020. This is unprecedented as the largest rate cut by the committee prior to this was a 0.35% rate cut in August 2019. The 0.75% rate cut is not only the largest by MPC, but also the largest since October 2004. In addition to the cuts by the committee, the governor announced a cut in the reverse repo rates by 0.25% in April 2020. This was specifically to discourage commercial banks from parking money with the RBI using reverse repo option.

Repo and Reverse Repo rates from April 2016 to Jan 2021. MPC began setting the repo rate in India from October 2016

Improved transmission of the policy rate cuts

These cuts in the policy rate were trasmitted onward in cuts in the lending rate and deposit rates faced by the economy. The Weighted Average Lending Rate (WALR) on fresh rupee loans (new loans issued by banks) declined by 0.94% between March 2020 and November 2020 while the WALR on outstanding rupee loans (loans issued earlier and still outstanding) reduced by 0.67%. The deposit rates also fell with the Weighted Average Domestic Term Deposit Rate (WADTDR) declined by 0.81% during the same period. Note that these are in response to the reduction in repo rate by 1.15% (0.75% + 0.4%) and reduction in reverse repo rate by 1.55% between March to May 2020. The improved liquidity in the economy due to various measures by the RBI buttressed the reduction. Earlier, RBI had mandated that all fresh loans that have a floating rate be linked to an external benchmark (repo rate, T-bill yield etc) from October 1, 2019. Given that the central bank was concerned that the rate cuts it offered commercial banks were not being passed on commensurately to end consumers, the improved transmission of late is a relief to policymakers. The graph below shows the recent decline in the spread between repo rate and lending rate.

Reduction in spread between lending rate and repo rate. Figure from Chapter 4, Volume II of ESI 2021.

Larger Liquidity

The financial year 2020-21 saw increases in aggregate money in the economy (M0, M1, M3) and a larger liquidity in money markets.

The RBI undertook many measures to increase liquidity in the economy, and I list a few major ones:

  • It purchased central and state government bonds worth 3 lakh crores.
  • It provided cheap loans to commercial through Targeted Long Term Repo Operations (TLTRO) and Long Term Repo Operations (LTRO). Loans given under repo operations are usually short term, overnight or for a week. LTRO provide loans of 1-3 years duration at repo rate, thus making long term loans available at a lower rate. TLTRO has an added condition that loans under these should be directed to specific debt instruments (corporate bonds, commercial papers and non-convertible debentures) so as to reduce the cost of borrowing faced by corporates.
  • It reduced Cash Reserve Ratio from 4% to 3%.

These increased liquidity in the system which in turn contributed to increase in aggregate money and reduction in interest rates and bond yields.

M0 (reserve money or high powered money), which, as defined in India includes the currency in circulation and deposits with the RBI, increased by 15.2% over the previous year. M1 which includes M0 and the demand deposits with commercial banks increased 20.5% over previous financial year (until January 1, 2021). These increases were driven by the larger liquidity in the system. M3 (broad money), which includes M1 and time deposits with banks increased 12.5% only in the same period. The increase in reserve money not translating to increase in broad money can be explained due to poor credit growth in the economy owing to which banks were parking the money under reverse repo window.

Table snapped from Chapter 4, Volume II of ESI 2021

Bond Yields

The large amount of bond purchases by the RBI as mentioned earlier led to a rise in the prices of government bonds. Increased prices mean lower bond yields and this was seen in the market. The reduction in yields was larger for shorter term bonds than for longer term bonds. This can be seen from the yield curve below. A yield curve plots the yield (in per annum terms) on bonds across varied maturities. The yield per annum of a longer term bond is usually (not always) higher because the longer term means larger risk from a future rise in inflation. The graph shows multiple yield curves pertaining to different months in 2020. One can clearly see that yield fell across all bonds, but the fall was larger for shorter term bonds. A lower yield is beneficial to the government as it can now issue fresh bonds and raise money from the market at lower rates.

Steepening of the yield curve in 2020. Figure from Chapter 4, Volume II of ESI 2021

The benefits of a lower yield were enjoyed by the corporate sector as well. The yields on AAA and AA rated bonds reduced in 2020. Here again, the reductions were much larger in the shorter term bonds than the longer term ones.

The ESI doesnt explore why the yield curves of government and corporate bonds steepened, i.e. difference between short term yields and long term yields increased. This could be because markets expect the policy rates and to rise in the long term.


The Economic Survey of India 2021 which provides a summary of the economic situation of the country for the previous year and also outlines the opportunities and challenges lying ahead has also summarised the monetary developments in the country in the last year. The policy rate and interest rates in the economy dropped, there is surplus liquidity in the economy and bond yields for both corporate and government bonds have fallen.

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