FE Editorial : What to stimulate

The Financial Express
Posted: 2008-12-13 00:48:22+05:30 IST
Updated: Dec 13, 2008 at 0048 hrs IST

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: In October, India was the only industrial Bric to crash. Industry growth was falling, but positive, in China (8.2%), Russia (6.9%) and Brazil (0.8%). India registered negative growth, a 0.4% fall in IIP—the sharpest contraction in output since April 1993. The extent of the fall and even the fall itself surprised most pundits. Is India going to be the worst-off among major developing countries? It’s too early to tell, and talking down growth rates is no more useful than trying to talk them up, but it’s not too early to ask whether the government’s stimulus packages may be too unambitious and/or wrongly directed. Some of the data makes for fairly scary reading. Ten out of 17 major manufacturing sectors registered negative growth in October. Both durable and non-durable consumer goods did badly. But that may not be the only or, some argue, the worst problem. Before looking at non-consumption demand problems, one should ask why RBI is taking its time redeeming the short- and medium-term market stabilisation scheme bonds. Redeeming MSS bonds will exert downward pressure on interest rates and will allow more policy headroom.

Many observers familiar with corporate India argue that the cash crunch faced by companies, and not faltering consumer demand, is the biggest crisis coming up and that trying to stimulate demand while suppliers are running out of cash may be a costly folly. But how does one address this problem? Getting banks to lend liberally seems the best bet. PSU banks have been directed to offer cheaper rates for low-cost homes. But that’s not a replicable option for other economic activities. Economists are talking of achieving a low correlation between company cash flow and company investment. Translation: lenders must make loan decisions looking at future cash flows, not current positions of firms. Basically good companies, and there are many such in India, shouldn’t be denied credit. For this, banks have to change their habit and no one’s sure now how this can be done. This presents a big policy challenge for the government. Investment-to-GDP ratio is around 38% in India now and a substantial drop in investment can have a big impact on GDP. Everyone knows India’s economy has great long-term prospects. The government has to figure out how to improve investment sentiments now.