India - Countering the slowdown

The Reserve Bank of India’s decision to pump in additional liquidity through a series of monetary and administrative measures was unexpected. In its mid-term review of the credit policy just a week earlier, the RBI did not effect any changes in key policy or statutory rates, belying widespread expectations. The particularly sharp fall in the stock indices was one direct consequence but in changing its stance so soon the central bank has apparently been prompted by the severe liquidity shortage that choked the system very recently. Short-term money market rates that came down after the RBI injected a massive Rs.1,85,000 crore through a number of monetary measures since mid-September were once again going through the roof. As has been pointed out yet again by the Prime Minister, the impact of the financial sector crisis on the real economy is likely to be severe and prolonged. The government has said it will do all that it can to ensure availability of bank finance for productive purposes in order to maintain the growth momentum. In effecting a reduction in the CRR and the repo rate by one percentage point each, the Reserve Bank has also been guided by the fact that many central banks including those of the U.S., Japan, and China have very recently brought down their benchmark lending rates. The Reserve Bank has also addressed liquidity concerns of mutual funds and non-bank-finance companies. The decision to unwind the market stabilisation scheme and the relaxation of SLR requirements are a part of the unconventional measures promised in the credit policy and they will improve liquidity further.

Stock markets in India have responded positively. However, a more enduring test of the recent monetary measures will be the way banks overcome their risk aversion and resume lending to the productive sectors the way they were doing earlier. According to reports, there are many instances of bank credit being denied even to blue chip borrowers. The plight of small and medium enterprises is said to be far worse. Domestic consumption that had spurred growth until recently needs to be propped up again, partly through a judicious disbursement of bank loans. Over the next few weeks the government, the RBI, and the banks will have to work in a concerted manner and ensure that the liquidity now made available is used to arrest the growth slowdown. While there are expectations of further rate-cuts and liquidity injections from the RBI, it is perhaps time to take a more serious look at what fiscal policy can do to stimulate the economy. Monetary policy instruments alone may prove inadequate to the task of countering the slowdown.