Booster dose #4: more money, who wants it?

Enough money has been thrown at banks, industry and consumers. But none of them are showing any interest in it. The RBI has given Rs 300,000 crore in additional liquidity to the banking system, which seems like a lot that has achieved very little other than preventing a financial sector crisis. But now that banks are safe, what’s the guarantee one more round of lollies will force demand out of its hiding?

But the RBI has to be seen as doing its bit. So, it has reduced the repo rate (the rate at which banks borrow from the RBI under the liquidity adjustment facility) from 6.5% to 5.5% and the reverse repo (where banks park surpluses with the RBI) rate from 5% to 4%. In addition, it is also reducing the cash reserve ratio, that portion of deposits that banks hold in reserve with the reserve bank, by 50 basis points to 5%. That will release another Rs 20,000 crore of cash into the system.

Why all of this matters little

See the RBI’s message, in the same release. It is asking banks to monitor their debt portfolio, restructure bad loans and preserve asset quality. It says that risk management is difficult under normal circumstances, and is even more difficult in an uncertain environment. Hardly sounds like: go out and lend. Banks will pump out cash to that long line of borrowers only if they are sure the money will come back. Financiers always say that it’s easy to lend money, there will always be takers, getting it back is the difficult part.

Then, there is industry. Debt comes with a cost. It makes sense when returns on your business are high. Some years ago, when money was available at 8% and your EBIT margins were an unbelievable 20%, it made so much sense. But when money is available at 10% and margins have dropped to 10% or even lower, it doesn’t make sense any more. That’s something bothering companies, especially the mid-sized and smaller ones.

Next, we come to the consumer, the well-heeled type who can buy cars, houses, electronics and clothes and send that plunging demand graph upwards. He is getting money cheaper for sure, but all this talk of cost cutting and layoffs is not making him confident enough, to go on a spending spree. And his stock market portfolio is in the dumps and if he bought a house in the past 2 years, chances are he is sitting on paper losses. He will wait for life to become secure again.

That leaves the masses. Now wholesale price inflation may be at 6.4%, but consumer inflation is above 10% and food inflation (in the WPI) is rising and above 12%. Who is the government trying to fool, by talking about falling inflation? After many years, we may see expenditure on food actually going up -much more than other sectors- in private final consumption expenditure.

What of the road ahead?

The government has to stop looking to the RBI to do its job. It’s a fiscal stimulus that is needed not as much a monetary one. If the individual is not spending, the government must. It must build more bridges, power plants, roads, metros and if possible give a little extra cash to its citizens, through tax cuts. The services sector will take care of itself, but only when the US economy revives. But the government finds itself in a situation, of its own making, where the fiscal deficit is running out of control. Tax revenues are not as buoyant and once SEZs gain critical mass, tax revenues will get hit further and even states will lose revenues.

Ultimately, the recovery will come down to one thing, luck or the sheer law of business cycles. We grow for five years, stumble for five, then grow another five (no scientific basis for the number of years). In growth years, the government will take credit, when the cycle turns bad, it will blame global market forces and the central bank’s tight money policy. And, the RBI stoically takes it all. As for stock markets, as of now, it all seems up to global liquidity, which was responsible for the mad rally in the not so distant past.

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