On Thursday, the Reserve Bank of India (RBI) paused its policy rate-easing cycle after an uninterrupted series of cuts all through this year as the economy lost pace. The central bank had already reduced its repurchase rate, the one at which it lends money to commercial banks, to an inflation-adjusted half a percentage point. This is about as cheap as cheap money gets. But, alas, it has not achieved much. In any case, the cuts have not fully filtered through to banks, which, constrained by high deposit costs, have lowered their own lending rates by only a fraction of RBI’s rate reductions. Now, if food inflation refuses to fall or feeds into general inflationary expectations, further rate cuts could take its real interest rate into negative territory. And, if it still fails its economic revival job, it would expose the limits of such monetary easing as a tool. In a worst-case scenario, it could even raise the spectre of a liquidity trap—where lenders lose their incentive to lend. In all, RBI seems to be signalling that it is almost out of ammunition, and that it’s time for the government to act. As if to convey this loud and clear, the central bank has also slashed its growth estimate for 2019-20 drastically. It is 5% now, down from 6.1% declared just a couple of months ago.
Now that the task of hauling the economy out of its slump is squarely the government’s, central finances will come back into focus. Could a burst of extra spending do it? That would depend on what it spends on and the sort of demand it generates. But here, too, risks abound. With heavy expenditure committed already, the Centre’s fiscal space is limited. Unless revenues stage a sharp recovery and sell-offs raise more than planned, this year’s deficit could slip well past the budget target. Since central borrowing has barrelled on, buyers of treasury bonds are offering their money at rather high rates of interest. A fiscal binge at this juncture might push bond market yields further up, negating some of RBI’s efforts to keep a lid on the cost of capital, and could also prove inflationary. It has been suggested that RBI supports a big fiscal leap; that it should slurp up bonds in its own version of “quantitative easing". Such a rash experiment, however, could go badly wrong if the money spewed out does not reach the real economy and inflates asset bubbles instead.
Perhaps the answer simply lies in getting wallets to open and households to spend more. Disposable incomes could be raised via tax cuts, and bigger welfare transfers to the hard-up could get cash changing hands. Voices from within the government have hinted at this twin-pronged approach, with an accelerated disinvestment programme taking some pressure off the fisc. But this faces its own set of challenges. Transfers would need to be aimed well, for example, while the Centre’s infrastructure projects would need a buy-in from states, which are mostly cash strapped. Even then, this strategy would only address cyclical aspects of our slowdown, while there is reason to suspect that structural constraints need easing as well. This would mean taking a close look at every sector of the economy for signs of anything that prevents market forces—of demand and supply—and their price mechanisms from playing an efficient role in the allocation of our resources. Of course, this would imply an all-out shift to a market economy. It may shake things up, but also achieve results.