India’s $5 trillion dream needs more than just interest rate cuts

• The spotlight is back on RBI ahead of its monetary policy and the speculation is rife that there may a sixth interest rate cut is likely in December.
• If the RBI cuts interest rates in December, it will be the sixth time this year.
• However, cheaper loans may not solve the crisis of confidence in the Indian economy. As Raghuram Rajan advised, the current slowdown may be an opportunity for structural reforms.

Be it Prime Minister Narendra Modi, Finance Minister Nirmala Sitharaman, Home Minister and party heavyweight Amit Shah⁠— all are selling the average Indian voter the dream of being part of a $5 trillion economy by 2025.

But the odds are against it. Even if one were to $5 trillion is just a symbolic number for fast growth, and not a definite goal, the harsh realities on ground will mean it will take a lot more to get the economy moving. Every 2 months, the spotlight is on Shaktikanta Das, the governor of the Reserve Bank of India (RBI), to make loans cheaper. He has delivered on the expectations five times this year, and a sixth cut in interest rate is predicted on December 5. But that alone may not be enough.


Currently, the economic growth is at a six-and-a-half year low, and has been on a downtrend for 15 months in a row. What makes it worse is the unpredictability around it. Even experts have had to revisit their projections on a monthly basis because things are getting worse by the day.


Firstly, growth needs money

The amount of credit in the system has gone down drastically. As veteran stock market investor Vallabh Bhanshali warned, in an interview with Business Insider, the money supply in India today is what it used to be in the 1960s, when the economy was growing at a measly 2-3%. Since then, it has only gotten worse.



The money has to pass through, it hasn’t

While the RBI has cut interest rates by 135 basis points since February, most Indian banks’ passed on less than a third of it via lending rates. So loans aren’t getting cheaper for the average borrower as it is for the banks.

What is worse, more interest rate cuts will hit family savings for most Indians who prefer bank deposits to evolved financial products. This will further dent consumer demand that is already tepid.



Not just that, the banks aren’t lending enough either. The reason why the money supply has reduced sharply is because the banks, saddled with bad loans, are increasingly shy of risk. Bad loans can’t be wished away, neither can the money be recovered by prayers. The non-banking financial sector, which is nearly a sixth of the economy, is in dire straits.

Not just that banks have been reluctant to lend to these shadow banks, they are not able to raise money from the bond market either. This is because nobody is sure which is a safe firm to lend to and which won't be able to pay back the loan.


It is not like NBFCs aren’t raising money because interest rates are too high. The market rate for ‘AAA’, the top-rated, bonds have steadily come down in the last one year. It is not a question of who can afford the loans, but it is actually about who can avail it.


So, as renowned economist and former RBI governor Raghuram Rajan advised, the bad apples have to be separated from the good ones, which should then given the required capital to grow. India's state-owned banks, which control over a third of India's bank credit, are infamous for taking orders from their political bosses before making loans. This has been a big contributor to current pile, nearly $140 billion, of bad loans given as, or in lieu of, favours.

Now may be the time for the government to tell these banks to pass on the interest rate cuts to companies that are in distress but follow good governance standards.

Make the consumers feel good, companies will follow

The Indian government has announced sharp tax cuts for Indian corporates making fresh investments. But who is going to buy the products that companies make. The consumers, and they aren’t in a good mood either.

The Indian consumer is a lot more stressed today than he was a few years ago. Household savings are declining and income isn’t increasing at the necessary pace.

That is for those who have jobs. Millions of people have gotten laid off in industries like textiles and automobiles that have undergone serious contraction.

Consumer confidence is at a six-year low, according to an RBI survey at the end of September. Once there are buyers, there will be sellers too. It is really a crisis of confidence and not interest rates in India.

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