Purchasing Power: DNA: 17th December 2008

The ultimate hallmark of successful globalisation in economics is when all nations are placed in a similar corner on account of a single factor. In the growth phase, there is a disparate performance across countries.
The developed nations always fare better which provokes critics to say that the gains of globalisation are always unequal. However, when there is a downturn, everyone suffers. Globalisation becomes a kind of a leveller. This is the case with all economies today with every country trying to cope with the pains of the financial crisis which has spread like a contagion.
The policy response across the globe has been cohesive — slashing of interest rates. The basic idea is that when demand is sluggish, the only way out is to provide a stimulus through lower interest rates which enable industry and individuals to borrow more, which will push up demand and hence growth. This is the classic monetary policy approach to a downturn.
Two issues arise here. The first is whether or not individuals will spend more money because loans are cheaper. Mortgage rates have been lowered by banks for loans of up to Rs20 lakh. The decision to take a loan will actually depend on the condition of the borrower. Is the borrower today really in a state to take a loan?
This is important because a dwelling purchased with a loan has to be serviced for a period of, say, 10 to 20 years. The present state in the private sector is grim with job loss threats and cuts in salaries looming large. The last thing on one’s mind will be to take on more debt for a protracted time period. The public sector may be better off with the Pay Commission hikes, but as most arrears will not be paid immediately, there would be some hesitation on their side too. Hence, at the individual level, expenditures may be deferred.
If we look at companies now, will they borrow more? Investment decisions are based on consumption expectations and existence of spare capacity. While evidence suggests that capacity utilisation may have crossed 80 per cent in the capital goods segment, the same is not evident for consumer goods. There is spare capacity which has been affected by the downswing in demand due to lower purchasing power. The better kharif harvest has not been translated into higher spending. Thus, today we have a situation where interest rates have been lowered and liquidity is adequate. Yet, while growth in bank credit is steady, there is no pressure on funds. Clearly, industrial demand has to pick up to fill this lacuna.
While the government is aware of the possible lags involved in monetary policy measures working out, it has simultaneously drafted policy on the demand side, which is quite different from what governments worldwide have done. It has embarked on an expansionary policy in the Keynesian genre — when economies slow down, governments should spend more as this generates investment, more jobs and higher consumption. The measures announced were in the direction of higher spending on the Plan account and more funds for rural sectors. This was topped by an across-the-board reduction by 4 per cent in excise duties.
The India Infrastructure Finance Company will raise Rs10,000 crore to boost the infrastructure sector. The total package of over Rs30,000 crore is to set the tone for growth from the point of view of consumption.
The government has actually taken that stance that it is no longer worried about the fiscal deficit. One may recollect that the government had arrived at a fiscal deficit level of 2.5 per cent of GDP for 2008-09. This had not taken account of loan write-offs and the Pay Commission burden. Now with the excise duty cut and higher Plan expenditure resulting in an additional cost of Rs30,000 crore and the higher food subsidy of Rs20,000 crore, the original target will be exceeded by 40 per cent, leading to 5 per cent fiscal deficit. But, under such circumstances, it can be justified as being necessary.
So, will these measures work? The answer is a big yes as lower interest rates and higher spending are just the antidotes for recessionary conditions. However, the time-impact is not going to be instantaneous.
Demand for consumer goods will not increase until buyers are more upbeat about their jobs. The auto and white goods sectors have to wait for a while. Real estate prices have to move southwards for the spending spiral to begin. Monetary policy will work with a lag as, at present, there is surplus liquidity which when absorbed as investment would involve gestation lags of at least three months. Tax refunds could have been considered but once again there is the risk of such refunds taking time and being stacked as savings. This simply means that we need to be patient and settle for lower growth this year (RBI has already indicated so). But, tomorrow may be brighter than today — that is the immediate hope.