INDIAN ECONOMY SLOWDOWN
10, Aug 2019
Prelims level : Economics Mains level : GS-III- Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.
- The Indian economy is facing one of its most challenging times in years, and policymakers are responding to the crisis through monetary measures, such as tweaking key interest rates.
RBI Monetary Policy:
- The Reserve Bank of India, in its bi-monthly monetary policy meeting, lowered its growth projection for the current financial year to 6.9%, from its earlier forecast of 7%.
- India has already lost its tag as the world’s fastest-growing major economy after GDP growth in the March quarter of financial year 2019 slipped to 5.8%.
- Taking note of the sagging growth, the central bank cut the repo rate – at which it lends to commercial banks – by 35 basis points to 5.4%, the lowest level since 2010.
- A basis point is one-hundredth of a percentage point. This marks the fourth consecutive time the key interest rate has been slashed since February 2019.
Why RBI cutting Repo Rate:
- The reasoning is that lower interest rates will reduce the cost of loans and stimulate falling consumption.
- The current economic slowdown has been widely attributed to tepid demand, which has, in the past been the key driver of growth.
- Weak consumption is evidenced by muted demand for automobiles, air travel and fast-moving consumer goods in recent times.
- The automobile industry, in particular, has witnessed a long-drawn slowdown, resulting in significant job losses.
NBFCs Shadow banking:
- One reason for the weak demand is the crisis in the shadow banking sector, or the non-banking financial companies.
- The lack of credit for big-ticket spending may have played a significant role in the slump in automobile sales, for instance.
- The RBI is, therefore, attempting to increase liquidity flows to non-banking financial companies by allowing banks to invest more in shadow banks.
Limitation of Monetary Policy:
- It seems appropriate that a crisis, which has its origins in the financial system, should be solved through monetary measures.
- However, the dynamics of a modern economy may mean that monetary policy moves alone will not be enough, and fiscal policy tools, too, will have to be deployed to deal with the situation.
US similar Situation:
- Parallels of today’s economic situation can be seen in the US experience of 2008. That year, the recession began in the mortgage industry.
- The inability of consumers to repay their loans resulted in financial stress for the mortgage firms.
- This later spread to all major banks and financial institutions that had invested in assets backed by these mortgages.
- A good part of monetary policy was initially focused on introducing substantial amounts of liquidity into the system.
- The official interest rate was reduced until it hit zero and could be reduced no more.
- Failing banks were propped up through interventions by the US Federal Reserve.
- Monetary policy took the form of large-scale quantitative easing.
- The Federal Reserve bought stressed assets and securities from banks by simply creating money, in an attempt to increase liquidity and clean up banks’ balance sheets and get them to lend again. Yet, these measures were inadequate. Interest rates remained close to zero for years, with the economy being slow to respond.
- Quantitative easing might have helped limit the extent of the recession but did not revive growth significantly.
- Ultimately, fiscal policy measures were needed for a full recovery.
Why financial crises cannot always be solved through monetary and financial measures alone:
- The reason why financial crises cannot always be solved through monetary and financial measures alone is because of the knock-on effect unemployment can have in an economy.
- The current fall in demand for automobiles in India has led to about 350,000 workers losing their jobs since April. These workers may not be consumers of cars, but they will reduce their purchases of clothing and other consumer durables, for instance.
- And those who otherwise earn their incomes from the sale of vehicles, such as owners of showrooms or retailers, might choose not to purchase cars due to their businesses facing reduced demand, even if interest rates are low and non-banking financial companies resume lending.
- Unemployment can have a multiplier effect, on various spheres of the economy. On seeing reduced demand, manufacturers and business-owners might reduce their expectations of future profits and might cut back on investment plans.
- In financial year 2018, unemployment in India stood at a 45-year high of 6.1%. An increase in the availability of credit to consumers, therefore, may not necessarily be enough to induce spending again.
John Maynard Keynes said:
- Monetary policy in the face of serious economic crisis becomes similar to “pushing on a string,” unable to exert any effect on demand.
The need for fiscal policy:
- To be sure, there are differences between the 2008 crisis and India’s current problems.
- For one, the US suffered negative growth rates, while India is still growing, albeit at slower rates.
- Secondly, Indian interest rates still have sufficient space for further reductions, unlike US rates which reached near zero and could not be reduced further.
- Yet there are grounds to be concerned. The current crisis compounds the problem of record unemployment the economy is already facing.
- It is imperative that fiscal policy is used and demand be revived, through public spending to shore up the economy.
- Adhering to a strict fiscal deficit target may prove to be counter-productive in the face of a widespread reduction in demand.
- The world has enough experience to see how crises that start in financial sectors can rapidly spread outwards, and it is imperative to take all steps to combat the problems the economy currently faces.