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A few days ago, the reporter had visited some parts of Uttar Pradesh (UP). While he was there, he interacted widely. The current status of the Indian economy was an important part of those interactions. Many of these discussions revolved around the high level unemployment and the increasingly irregular nature of jobs. As a business journalist, he shared his insight on the falling rates of interest of the economy and on the share market’s puzzling behaviour, which is rising, amidst a slowing economy. The two issues are discussed below.

Can RBI reverse the trend by its monetary policy?

The Reserve Bank of India (RBI) has kept the repo rates unchanged to 5.15% and the reverse repo rate at 4.30%. At the same time, it has lowered its GDP growth forecast to 5% for the 2020-21 fiscal.

It was expected that after a series of lowering policy rates, the RBI will follow a similar path and make the cost of funds cheaper. That may boost investment at a time when growth rate of the GDP has come down to 4.5%, its lowest in six years. A section of economists accepts this course of action, which follows the Keynesian economic theory that states economic activity can be increased by lowering the rates of interest.  But if one goes into deep analysis, it will be clear that it is not as simple as it is understood to be. In this situation, economic activity cannot be increased by the desired level by only lowering interest rates. So what is the theoretical foundation of the relationship between growth and interest rates?

John Maynard Keynes in his book General Theory of Interest Employment and Money said that only weakening monetary policy, may not be sufficient to lift a slowing economy. There can be “several slips between the cup and the lip”. This is because by lowering policy rates, an economy may not have an adequate impact on long term investment plans that involves capital investment in new initiatives.

Ishan Anand of Ambedkar University and Rohit Azad of Jawaharlal Nehru University have pointed out (India’s Slowdown-What It Is and What Can Be Done, Economic and Political Weekly October 12, 2019) that despite a fall in the repo rate, the prime lending rate has not fallen correspondingly and instead, the gap between the two is being widened. This has not helped the investment scenario in the Indian economy.

Secondly, the fall of interest rates can enhance investment only if the investment is sensitive to this fall. The study on the ‘Annul Survey on Industry’ data done by Anand and Azad found that the interest rate has hardly any effect on investment. Thirdly, considering two situations when either consumption falls due to thriftiness in conditions of slowdown or because of an increase in imports in the case of an import intensive situation in the economy. Both of these cases will counteract the rise in investment by lowering the output multiplier. This situation overshadows any possible revival in investment. This is why the slowdown of the Indian economy is persisting despite the lowering of interest rates.

Recently Rajnish Kumar, Chairman, SBI, said in an interview that investors do not care for interest rates. When it was 12% earlier, there was no dearth of demand for loans from banks. Relating the Indian situation to the world experience is also important. In developed countries, the rates of interest have been very low, in some cases as low as zero or even negative. This is experienced in Japan, in the EU countries and in the US. But such policies of those countries have failed to boost investment to the desired level. In case of India, continual reduction of policy rates have also dragged down the deposit rates of banks. This has engendered those people who are to depend on interest incomes for their living. Senior citizens and many dependent people are now in trouble. This has lowered the purchasing power of many people and that has weakened the economy. The present monetary policy of the RBI is unable to boost the economy. It should keep a stringent watch over the economy and act accordingly.

Slowing economy and rising stock markets

The Indian economy has been slowing down for many quarters. In this backdrop, it is puzzling to note that the stock markets are soaring. A few days ago, the BSE index touched the 41,000 marks and Nifty 50 crossed the 12,000 mark. 

The first thing is that if one considers the Nifty 50 indices, it is clear that only a small portion of stocks are actually rising and that is responsible for the rising Nifty indices. Reports point out that about 25% of the small-cap and 40% of the mid-cap funds are below their all-time high. In this situation, a small portion of quality large-cap stocks are responsible for the rising stock markets even in the midst of a slowing economy. Within the Nifty 50 index, the entire returns have been coming from only 15 stocks.

Akash Prakash of Amansa Capital has pointed out this phenomenon in an article. If one divides the Nifty in two groups, having the 15 top performing stocks in one group and the rest of the stocks in another group, it will be clear that since December 2017, out of the 50 stocks only the top 15 stocks indexes are up by about 40% while the indexes of the remaining 35 stocks is down by 19%. 

In another study, published in a national media a few months ago, it was observed that for about 85% of all stocks in Indian stock markets, the shares have either not been traded at all or have not been advancing their prices or been negative.

Why are prices of only some stocks rising?

There are two reasons. First, shift of buyers’ preference. In this volatile situation, stock buyers prefer quality large-cap stocks - even at very high prices. So, an imbalance in choosing stocks is clear. Secondly, there has been optimism among a section of buyers about the prospects of the economy in near future.