June , 2020
Indian economy in liquidity trap
00:05 am

Kishore Kumar Biswas

Many economists think that the Indian economy has entered into liquidity trap situation. The idea of liquidity trap is a concept. This was observed in the early 1930s in many Western countries particularly in the USA during the period of Great Depression. What is the idea of liquidity trap?

The idea was first propounded by famous economist John Hicks in his seminar paper, “Mr. Keynes and the classics” in “Economica”, 1937. The purpose of the article was to review Keynes Magnum Opus General Theory of employment, Interest and Money. Why an economy (the USA in 1930) suffered a prolonged depression? It was due to some factors and most importantly due to liquidity trap like situation prevailing in the economy. When monetary policy fails to increase, investment and income of an economy even by lowering interest rates at very low level, demand for investment and even consumption cannot be boosted. In that situation people hoard cash or are not interested in investing in any new investment projects. This is because people expect an adverse event such as deflation, insufficient aggregate demand or war in the coming days.

Present trend in credit growth

The bank credit growth in India can be found in the data of credit lending by various commercial banks. There are 46 commercial banks in India which account for 95% of the total non-food credit of the country. Another small portion is food credit indicating the lending made by banks to the Food Corporation of India (FCI) for procuring food grains. Here our purpose is to study non-food credit only.

The credit growth as a whole came down to 7.3 % in February 2020. It was 8.5% at the same time of the last year. But in the lock down period the credit growth must come down to very low level in the end of May 2020. But the data will be available later. The good quality was seen in February 2020 in personal lending section. It was 10.3 %. The credit to industry and priority sector in February 2020 came down to 0.7% and 0.3 % respectively in year on year basis. In India the bigger section is service sector. In that sector total loan was Rs.24.3 trillion in February 2020. This declining to a 30-month low growth of 6.9% in y-o-y.

In industry credit, growth in MSME is not at all rising. It is more or less flat at low levels. From RBI data it is seen that bank credit growth deteriorated to a five-decade low of 6.14% in March 31, 2020.

How to get out of this 

Indian economy has been passing through crisis. This has been deepened in the Covid-19 phase. Several national and international institutions predicted negative growth rate of the economy in FY2020 – 21. But how to get out of this and start reversal of growth should be the prime motive of the government.

The basic idea is to target sector wise and take policy stance to act accordingly. There are four sectors in an economy. The most important one is consumption sector. If the consumption remains stable, the economy may recover quickly. The second one is investment sector. This is very volatile in nature and sensitive also. Then comes the role of the government. Government expenditures may be stable but in India role of the government spending has been contracting in the sense that at least `10 lakh crores is reported to be due to different areas where jobs have been completed or incomplete due to repayments of funds. Government has to repay these due as soon as possible. The fourth one is foreign trade sector (export and import). This sector depends on so many factors like demand in foreign countries, relative price of goods, exchange rates etc. This is not totally controlled by domestic economy. Therefore, the most important sector is consumption and investment sector in the present context. But it is already seen that why the investment sector is subdued. It has to be increased indirectly. Now the consumption sector has the prime role to play to reverse the downward trend or the economy. But how?

This can be done through fiscal policy that is by the policy of the government to stimulate the demand level of the economy. By monetary policy it is possible to increase liquidity and availability of cheaper loan to investors. But cheaper loan cannot increase the demand for loan as the business prospect is not good in near to medium future days. It is only possible to increase level of demand by proper monetary policy. But government stimulus package is about 1 % of GDP. Economists think it is not enough for the purpose. Former Professor University of Calcutta and Finance Minister of government of West Bengal, Ashim Dasgupta told that the economy has been entering into liquidity trap. The government should go for fiscal measure by supplying the money directly for several months. Professor of Economics in Jadavpur University, Ambar Ghosh think the only way to get out of liquidity trap is that the government has to spend huge money by lowering not so important expenditures, printing money and other measures. Crores of people have lost their livelihood in this situation. So, government has the responsibility to restore their livelihood fully. This will help to revive demand and that may lead to rejuvenate the economy.

Add new comment

Filtered HTML

  • Web page addresses and e-mail addresses turn into links automatically.
  • Allowed HTML tags: <a> <em> <strong> <cite> <blockquote> <code> <ul> <ol> <li> <dl> <dt> <dd>
  • Lines and paragraphs break automatically.

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.