August , 2020
Measures to boost economy through banks involves logical contradiction
11:58 am

Kishore Kumar Biswas

The Indian economy has been going through a recession during the Covid-19 phase. However, the case of the Indian economy stands out. The economy was slowing down for about two years preceding the pandemic.

Economic growth came down to 3.9% in the fourth quarter of the last fiscal, which was the lowest in India’s recent history. Economists were talking about the downward consumption expenditure, mainly, of the rural population. This was noticed in urban areas and during the last two years or more. Gross Fixed Capital Formation (GFCF), a proxy for investment, grew by 1% in FY19-20 down from around 10% in the previous fiscal (FY 2018-19), according to advance estimates released by the Central Statistics Office (CSO). This suggests that GFCF witnessed a 0.5% contraction in the second half of the 2019-20 fiscal. The earlier low was minus 0.72 % in FY02-03. The share of investment in overall GDP was estimated to be 28.1 % which was the lowest ever based on the back-series data available. In FY03, share of investment in GDP was 28.3 %.

Recent measures to boost economy 

A lot of liquidity measures have been taken by the government to boost the economy. The repo rate has been lowered by 75 basis points to make the bank loans cheaper. The Cash Reserve Ratio of all banks has been reduced by 100 basis points to increase liquidity of `1, 37,000 crore in the banking sector. The Marginal Standing Facility was pushed from 2% to 3% on June 30, 2020. Additionally, the liquidity coverage ratio for banks was reduced from 100% to 80%. All such measures, along with a few others, are expected to increase liquidity by `4.74 lakh crores.

The Micro, Small and Medium Enterprises (MSME) sector is said to be the backbone of the industrial sector and it is also very employment intensive. Main incentives for the sector include `3 lakh crore of collateral free loan facilities with 100% credit guarantee, `20,000 crore for stressed MSMEs and `50,000 crore as equity infusion. The definition of MSMEs has been changed by revising the investment limit upwards to facilitate more units to get facilities and there would be no global tenders for government contracts up to `200 crores. Arrangements would be done for e-market linkage of trade fares and exhibition and MSME dues would be cleared within 45 days.  There are some relief proposals for Non-Banking Financial Companies (NBFCs) as well.

A logical contradiction can be traced

It is obvious that the Indian government is concentrating on increasing the investment opportunity of producing units by extending financial help to the existing or new units. If investment opportunity increases, there would be more investment and production would go up and there would be more employment and income generation. That would increase the demand in the market which in turn would increase production. However, here lies a logical contradiction.

It is true that in macroeconomics both investment and consumption are important but investment is more important than consumption. Theoretically national income (simply GDP) generation depends on investment. That is, if investment of an economy is raised by an amount then that leads to a generation of income by a multiple of that amount of investment in due course of time. But it is the propensity to consume of the consumers that determines this multiplier effect. So the success of the government’s measures to boost investment will depend on how much of the increased income of the consumers is spent in the market as consumption expenditure. Therefore, when the consumption level is very low and enhancement of income of the consumers is almost non-existent, private investment in the economy will not be forthcoming. Therefore, the present situation of very poor consumption levels will not be an exactly encouraging scenario for investors. This is why the government policy has not been working. If this situation persists, the possibility of revival of the economy would be more difficult. Actually, the sooner the implementation of the right fiscal policy is ensured, the better it would be for the economy. A policy that will increase demand in the economy may work better.

Economic outlook of RBI and the role of the banks   

Eminent observers like Deepak Parekh, Chairman, HDFC, has reportedly stated that the rural economy would be robust because of expected good Kharif crops. But the RBI observes in its industrial outlook released a few days ago, the chances of domestic demand to recover from Q2 and sustain through Q1 of 2021-22 is low. For FY 2020-21, the real GDP is expected to be negative. But a lot would depend on normal monsoons, early containment of the pandemic and the level of global financial market volatility.

The banking industry has been depositing about `7 lakh crore every day to the RBI as overnight deposits at reverse repo rate (3.35%). This means demand for credit of the banks has plummeted. The financial results of the banks in the Q1 of this FY are gloomier than what appears to be. This is because the RBI has diluted the norms of non performing assets (NPA) through the declaration of moratorium in loan recovery. But the banks have been booking notional interest and amortization of credit. But when moratorium will be repealed, it is expected that there might be a huge surge of NPAs. The RBI in its recent Financial Stability Report has expressed concern regarding this. The report mentions, “Macro stress tests for credit risk indicate that the GNPA ratio of all scheduled commercial banks may increase from 8.5% in March 2020 to 12.5% by March 2021 under the baseline scenario; the ratio may escalate to 14.7% under a very severe stress scenario.”

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