COVID-19 presents unprecedented challenges for the Indian economy and the government has been on its feet trying to mitigate the negative impact of this unprecedented crisis.
However, even well-intentioned policies will be of no use if the problems are structurally elsewhere. This is best explained in the case of government stimulus policies.
Following the closure of COVID-19, the Center announced an ‘Aatmanirbhar Bharat Abhiyan’ (ABA) package in mid-May, amounting to 10.3% of GDP, to stimulate the economy.
While the direct fiscal stimulus was less than 1.3% of GDP, more than 7.8% of GDP consisted of providing easy credit to MSMEs and farmers and injection of liquidity through various RBI measures.
Of the Rs 21 lakh crore package, Rs 9.73 lakh crore has been accounted for for possible injection of liquidity into the banking and financial system through various RBI measures (Rs 8 lakh crore) and otherwise, and Rs 6.25 lakh crore for the Easy unsecured or partially guaranteed loans expected (even with lower credit ratings) to MSMEs, farmers, etc.
The rest of the package deals with the creation of off-budget funds of Rs 1.7 lakh crore, the lost income of Rs 58,000 crore, the additional allocation of Rs 40,000 crore for the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) and Rs 1.7 lakh crore from PM. Garib Kalyan Yojana for the mere survival of the country’s poor.
Therefore, more than three-quarters of the ABA package deals with the possible injection of liquidity and the expected increase in the purchase of credit at the aggregate level.
The materialization of this possible injection of liquidity in a greater uptake of credit is conditional on the demand for credit in the market. Easy loans would boost aggregate demand for credit if, and only if, MSMEs and farmers do not replace their past debts with these easy loans.
Furthermore, the aggregate demand for credit would increase only if the aggregate demand for investment increases, which in turn, depends on the expected profitability of investment projects. The profitability of the businesses / investments is subject to the demand for the products in the market.
The aggregate demand for goods and services again depends on people’s income and purchasing power, which has been drastically reduced, at the aggregate level, due to the COVID-19 lockdown.
The central bank has been on a spree to cut buyback rates (the rate at which commercial banks can borrow from the RBI), resulting in an all-time lowest buyback rate of 4% in May 2020. to make it easier for banks to meet the increased demand for credit, if applicable, at a lower interest rate.
In addition, reserve ratios have been lowered to allow commercial banks to make more loans to investors, given their deposit base.
However, if the easier loans had been taken in addition to the existing loans, the credit-deposit ratio of all commercial banks operating in India (collectively) would have increased, at least after the announcement of the ABA package in the middle of the year. May. .
In other words, the capture of credit from commercial banks would have increased in relation to the deposit base (demand and term liabilities) with the banks.
Also, if there is a greater demand for credit in the market, banks would invest less in government securities and other approved securities (in case they have additional securities above the SLR standards) and offer more credit at an interest rate (of loans) relatively higher. because even the minimum loan rate is always substantially higher than the expected average rate of return on government securities.
Therefore, the possible injection of liquidity would update and improve people’s purchasing power to stimulate aggregate demand only when additional credit is taken from banks and invested on the ground. However, the available data tells us a completely different story (see charts below).
We have based our knowledge on data related to commercial bank business in India from the various editions of the RBI Weekly Statistical Supplements from January 3 to June 19 this year.
It is clear that the credit-deposit ratio began to fall fairly steadily after March 27 after the lockdown (a decrease from 76.4% on March 27 to 73.5 on June 5) and investment by banks in government securities has risen as a proportion of total credit issued (plotted along the secondary axis in the first panel) consistently after March 27 (from 35.6% on March 27 to 40.4% on March 19). June).
Even on March 27, banks’ investment in government securities and other approved securities was more than 30% of their net demand and term liabilities (NDTL), which was well above the legal reserve requirements. Therefore, the reserve ratios were not binding restrictions in any way.
The central bank’s motive behind lowering the reserve ratio was to expand the bank’s deposit base, as it expected there to be an increase in demand for credit and a decrease in bank deposits in the future.
On the contrary, deposits have continually increased and uptake of credit has continually declined since the blockade was imposed. As a result, the credit-deposit ratio has fallen steadily until June 5.
Consequently, injecting liquidity into the banking system has failed to boost credit growth because the problem is not the lack of liquidity but the demand for credit.
The latest observation on June 19 has shown a certain improvement in the credit-deposit ratio, but it is not due to an increase in the purchase of credit but rather due to the reduction in bank deposits (see panel 2 of the graph). Some people must have started withdrawing money for their spending from their past savings due to the lack of income caused by the closing.
The main cause for concern is that the demand for credit is not recovering. That will not increase until aggregate investment demand increases, and it will not increase unless business confidence about the size of the market improves.
If the aggregate demand for credit does not increase, clearly, 75% of the ABA package simply would not stimulate the economy. The unemployment rate would skyrocket, the growth rate would be hugely negative, and earnings, as well as wage rates, would be extremely low – the economy would enter a severe depression.
It’s not that anyone accepts government-guaranteed unsecured loans, even with a low credit rating. Many would take this opportunity to borrow on these easier terms, however that does not necessarily mean that aggregate investment or borrowing is increasing in the economy.
There is always the option of substituting past business loans for these new loans with full or partial government guarantees. If those companies have losses in the future and generate NPAs with the banks, the government has to write off bad debts using taxpayers’ money.
Basically, it is a risk diversification mechanism to regain investor confidence. The government is guaranteeing entrepreneurs (with an annual turnover of Rs 100 million or less) that their losses, if any, would be borne in whole or in part by the government (or taxpayers).
Socializing the risks of MSMEs and farmers is not a bad idea in the short term to rekindle investor confidence; however, this is surely not enough to return the investment rate to the level that the existing labor force in the country could absorb.
Losing private companies would be protected by taxpayers’ money, however investors would not make the investment to incur losses. Until, and unless, aggregate demand is revived by the greater purchasing power of ordinary people, aggregate private investment will not reach a sufficient level.
This is important to the life of such a gigantic population in India under capitalism. The government must bet on an expansionary fiscal policy (Keynesian demand management policy) financed with short-term monetization.
The early distribution of public spending through deficit financing with the universal employment program of last resort (with improved wages) is the need of the day. An increase in public spending on health and education would reduce people’s out-of-pocket expenses for these services, which, in turn, would improve purchasing power and reactivate aggregate demand.
While there could be a huge revenue shortfall for the government, this is not the time to pursue fiscal conservatism. Hopefully, the government reflects on these concerns sooner rather than later.
(Surajit Das is an assistant professor, Vaishali and Kirti Jain have completed their masters in economics at the Center for Economic Studies and Planning, Jawaharlal Nehru University (JNU), New Delhi).