Rate Cuts Alone Will Not Work: RBI

Amidst the on-going economic slowdown, the Reserve Bank of India (RBI) cut repo rate by 110 basis points (bps) so far. But the concerns are raised every now and then about the transmission of rate cuts to the borrowers.  The research report Ecowarp by State Bank of India, stated, “We believe the current slowdown cannot be tackled by monetary policy in isolation. The contemporary issue for macroeconomists is to exclusively focus on assuring adequate aggregate demand. We believe monetary policy could only act to some extent – experience shows we have been in an era of low interest rates for a decade but that has done little to boost aggregate demand but increasing household debt (in US it increased from $12.5 trillion in Q1FY08 to $13.9 trillion in Q22019).”

Somyakanti Ghosh, Group Chief Economic Advisor, SBI in the report reasoned, “Rather fiscal policy needs to be a major focus now, especially given what low or negative interest rates mean for the sustainability of deficits. Interestingly, total financial liabilities of Indian households have jumped by a massive 58 per cent in FY18 to Rs 7.4 lakh crore (after 22 per cent jump in FY17). In fact, while household leverage has jumped 2 times in the last 5 years, disposable income has jumped by only 1.5 times, thereby putting pressure on savings. Even though the jump is not as much as in 2007 (when it jumped by 2.3 times over 2005), such a large jump is a matter of concern.”

In order to increase saving through fiscal means the report stated, “Abolish capital gains tax to boost financialisation of savings that gained momentum in FY18, but might have lost pace in FY19. It is widely argued that a large part of financial savings of the households is used for financing of fiscal deficit. “

But this only tells one part of the story, as the incremental claims of government borrowings on households have increased by only Rs 60,000 crore for the 2-year period ended FY17. During the same period, the move to incentivise household savings through increasing the ceiling of Section 80C resulted in an incremental Rs 1.8 lakh crore of household savings flowing into tax saving instruments.”

In order to boost the consumption in the economy the report suggested a slew of measures and a few among them are that the government must address demand weakness by continuing to meaningfully frontload expenditure say through PMKISAN and MGNREGAPM-KISAN against the target of 14.6 crore due to slow validation in farmer data). 

The other option the report highlights for boosting consumption is to continue pursuing capital expenditure (only 32 per cent utilised till date). “However, in such a case, the Government should clearly state upfront that the additional fiscal spending is specifically for infra spending to boost demand and not for any unproductive purposes. The headline fiscal deficit should stay at 3.3 per cent, while the additional fiscal impulse for infra spending could be over and above this. To negate any impact on bond markets, the RBI could also frontload large rate cuts in October policy and also start doing open market operations that will keep the yields in check. We also believe that the Government should go ahead with the sovereign bond,” as has been stated in the report.