For much too long, the discussion in Indian policy circles has revolved around the need to cut interest rates as a solution to addressing our liquidity problem. But NITI Aayog vice-chairman Rajiv Kumar’s recent comments suggest reducing the cost of money may not solve the problem. He believes a trust deficit afflicts the financial system, with lending stuck and cash piling up unused. This crisis is “unprecedented", he says, and advocates extraordinary steps in response.
Indeed, if lenders aren’t sure their money would safely be returned, a reduction in the cost of borrowing, as the central bank has been trying to do, alone won’t help the economic much. Lenders would demand higher rates of interest to compensate for greater risk, if at all they agree to lend. That is perhaps a reason why credit growth hasn’t improved much despite the central bank’s policy rate having been slashed by 1.1 percentage points this year.
So, if a monetary push policy can’t aid a growth revival, could fiscal policy step in? Here too, the scope is narrow, with the government’s hands tied by underwhelming goods and services tax revenue and rising social spending. These have left little money to spend on infrastructure and the like. Tax cuts might boost demand, but that would leave even less money with the government. All considered, the best way out may be structural reforms that invigorate private investment. The current government has the political strength to adopt measures that may be unpopular at first brush, but are likely to prove worthy in some years once their benefits start showing. That’s a major advantage.