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Understanding Economic Crisis

Reserve Bank of India announced series of measures to combat Economic Crisis.

What are those Liquidity Boosting Measures?

  1. Reduced Reverse Repo Rate from 4 to 3.75 points
  2. Reduced Liquidity coverage Ratio
  3. Allocated 50,000 crore Rupees to NBFCS like NABARD, SIDBI and MFIs (Micro Financing Institutions) to enhance availability of Liquidity to MSMEs because 30% Domestic Product comes from MSMEs.

For common people to understand these measures they must know some basic:

  • Liquidity: Cash in hand or money available to spend.
  • Repo Rate: Interest paid by the Banks to RBI on money borrowed from RBI.
  • Reverse Repo Rate: Interest paid by RBI to the Banks on the funds parked with RBI.

Reduced Reverse Repo Rate from 4 to 3.75 points 

Every Bank or NBFC has FDs, unclaimed or surplus idle funds which they try to put to generate some interest by parking them with RBI….an estimate says a whopping 7 Lakh crore rupees of funds of different banks are parked with RBI, which were generating 4% interest till 17th April 2020.

Now that RBI has reduced the Reverse Repo Rate to 3.75%, banks will definitely think on reducing the parkings in RBI, because Banks pay us 5-8% on FDs and 3-4% on Savings.

This will increase the Liquidity of the Banks.

Reduced Liquidity coverage Ratio

Every Banking Institution is required to keep some % of its money in the form of ready available cash or High Quality Liquid assets like lending to Govt or PSUs for very short term. By reducing this Liquidity Coverage Ratio RBI has directly helped in increasing the Liquidity with the Banks.

This is not Financial Crisis

In an ideal condition this theory of Liquidity Boosting would have helped Industries and Businesses to avail more liquidity from the banks and increase their business activities. This in turn would have boosted our Economy and generated more Jobs.

In other words these measures are good in a Financial Crisis.

This is Economic Crisis

Why is this an Economic Crisis?

RBI fails to understand why are the Banks parking 7 Lakh crore rupees for just 4% rate of interest?

RBI thinks Banks are not wiping to take risk by lending the money and generate higher rate of interest.

Who will tell them that it is because there’s no Demand….there  is no Consumption.

Even if the Banks increase credits, the borrowers are unable to generate business and service the interest to the Banks.

Result: Increasing number of NPAs or Non Performing Assets.

Post Demonetisation and ill implemented GST, many businesses have taken dual near fatal blows, and many people have lost their existing source of income, to add to the crisis Govt has failed miserably in generating new Jobs. The Unemployment Ratio is all time high in 45yrs.

Govt has not thought of measures to Remonetize people, all they understand is to keep the Corporates cushioned by reducing the Tax burdens on them.

Today with the “ Chakka Jaam” situation due to Covid-19, can the Boost in Liquidity in Banks help in Boosting the Demand?

Absolutely no!!!

Reason: Demand can be created only by Boosting the Consumption.

What will Cheaper Bank Credit do?

With very low demand many people are finding it very difficult to service the interest for the existing borrowings, they will queue up for the cheaper or advances with lower rate of interest and  repay their old loans which were taken on higher rates of interest. But will not expand business activities.

In short Boosting Liquidity in Banks and extending it to the existing clients will actually not yield the desired results in the absence of Consumption.

How can we Boost Consumption?

Post DeMo people have gradually eroded their Savings as most of them lost their regular source of income due to Job losses or losses in business.

As a result the masses, the employed class, the farmers, the daily wagers all fighting cash crunch or reduced spending capacity.

Unless Govt thinks of ReMonetising the common man Consumption cannot be boosted and Demand will never be increased, no hope for Exports in near future.

Is NYAY the only way ahead?

Rahul Gandhi had suggested Remonetisation of the 25% population of India by ensuring a monthly income of 7500/- per family, he reiterated on his idea and was kind enough to let Modi Govt to rename it but ensure its implementation.

The Consulting Committee of Indian National Congress has asked for an immediate direct money transfer of 7500/- to increase Consumption and create Demand.

To Fight Economic Crisis with methods of combating Financial Crisis is like Band Aid treatment for severe injury in Pawan Khera’s words.

Looking forward to better GDP and Employment.

This too shall pass but we have to work in the right direction.

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