With economy in tailspin, the RBI has lowered interest rates several times, in order to stimulate borrowing, investing and consequently raise the economic growth. If rates are too low, they tend to spur excessive growth and inflation, lowering the purchasing power, undermining the sustainability of economic expansion. If on the other hand, there is too much growth, the RBI may raise interest rates, slow inflation and return growth to more sustainable levels. Very high rates lead economy to grow slowly, aiding even contraction. How does all this affect the current scenario?
GDP, a measure of the country’s economy, is based on the total value of everything produced by all the people and companies in the country. It is a summation of the total spending by consumers, the total investment or spending on goods and services by businesses, the total spending by government and net exports (exports minus imports). GDP can never be negative at least theoretically. When the primary sector that depends on produce from the earth or secondary sector on manufacturing, take a hit, and if the import bills hit the sky, like that on import of oil due to either dollar appreciating or crude price rising, compared to revenue accrued on account of aggregated exports, we would be staring down the barrel.
In these times of economic trouble or uncertainty, when the GDP has been falling for the previous three quarters, the government to its credit did try to address the downturn by distributing economic stimuli, in the form of rebates or checks. A negative growth is perceived when GDP falls from one quarter to the next bringing in its wake falling incomes, lower consumption and job cuts. The economy will be in recession if two consecutive quarters or six months is of negative growth. Health, relationships, education and skills, what we do, where we live, our finances and the environment, are all affected and in turn effect GDP.
RBI has cut the repo rate and reserve repo rate by 35 basis points respectively, in August this year which was the fourth, in this financial year. The short-term lending rate now stands at 5.40%. While a reduction in lending rates in the economy will clearly benefit loan takers, it also hits those living off income from fixed deposits when the rates go down. RBI may further cut key rates in time to come, probably skewing the game further.
Interest is what one pays for a privilege. It’s like hiring a car. Interest is what one pays to ‘hire’ someone else’s money. However, the benefits of cut in basis points translated to interest rates seldom travels down the line, to the last mile. The central bank seems to have taken a calculated risk, wanting to stimulate borrowing by consumers and investors. It is expected that the enhanced borrowing would, in turn, stimulate economic activity and growth.
Will the rate cuts, rebates or tweaking the corporate tax structures, pay dividends? The answer seems to be no. A financial gain rarely succeeds because people do not often change their spending habits. People are a lot more circumspect to fathom, that economic stimulus packages are due to economic downturns, and hence are even more reluctant to spend, instead putting them to savings and adding further to the downturn. Of course, savings too will spur economy, with the banks profiting, allowing them to decrease the interest rates, which then encourage others to save less, promoting future spending. This is good in theory and needs support of credible data to be proved or disproved. What happens in practice? How does, one measure what is earned and what is spent in a country where a large informal economy thrives? One gets different figures depending on which method one uses, because there’s never enough data to build a picture of the economy that’s 100% complete. Household spending forms the largest part, accounting for about two thirds of GDP. Demonetisation in 2016 hit this badly by sucking out all the money available for spending from small businesses, housewives and a large informal sector. The cumulative effect on economic growth is palpable which has slipped to a six-year low of 5% for the June quarter and is expected to turn in even lower, in the next quarter.
GDP growth, is not the whole story when gauging how well economies are doing. Some things are valuable but are not captured in GDP because money does not change hands like when elderly relatives are cared for. Einstein was right when he said, “Not all that can be counted counts”. GDP cannot tell us how evenly income is distributed across the population. Growth may mean everyone becoming better off or the richest section getting even richer. There are also things which raise GDP that don’t make the country better off. The constant skirmish in J&K is one example where a lot of money is spent, so GDP goes up or if a large part of a forest was cut down or a pristine mountain raged in one week, for a new development project, one would get a sharp rise in GDP from the sales of timber and stone, but at a huge environmental cost.
Another concern is the automobile sector, where the crisis is real with the demand for cars hit, by lower lending, by the non-banking financial companies. After the crisis at the ILFS, the NBFCs have found it increasingly difficult to borrow affecting their lending capabilities. In a vicious cycle, with car and two-wheeler sales going down, even commercial banks have reduced their lending to the sector. High goods and services taxes, the explosive growth of ride-sharing through Uber and Ola, and a weak rural economy only added fuel to the fire. Making EMI’s cheaper is a solution that is not going to please any.
What can the policy makers do now? Rate cuts work only if the investor confidence is restored. A stable economic policy and investor-based reforms must be pursued. A constant chopping and changing GST rates must stop. External headwinds from trade wars and tariffs initiated by the US and China must be watched closely. Not going along with the Regional Comprehensive Economic Partnership (RCEP) is a good move for the present, though in highly globalised markets, is a Hobson’s choice.