The Indian economy has logged a growth of 5.3 percent in the third quarter (Dec- Oct) of the current fiscal year. Though below the estimated rate, the 5.3 percent growth is still reassuring when we see gloom and doom around us in other global economies.
But this growth figure is on y-o-y basis. In a time of economic crisis like the one the world is facing today, it is important to monitor economic parameters more closely to avoid misplaced reassurance. If one looks at the third quarter in isolation and not on the
y-o-y basis, then the growth rate is actually zero! This implies that economic activities came to standstill. This has happened despite the Reserve Bank of India (RBI- India’s central bank) further reduced its lending and deposit rates for banks. The cut in lending rate should have encouraged banks to borrow from the RBI and cut in deposit rate should have discouraged banks from depositing their surplus funds with the RBI. Thus, the surplus funds should have gone to markets. But that is also not happening. Banks are not lending, being wary of creating bad assets. (ICICI bank’s chief Kamath has gone on record saying his bank would not give loans for two-wheeler purchase) Banks, both private and public sector, instead prefer to park their surplus liquidity with the RBI even though the interest rate offered is just 3.5 percent. As per an estimate, Indian banks have parked as much as 97 percent of their surplus liquid capital with the RBI. The resulting unavailability of credit is starving the economy.
There are several events before and in the aftermath of the global meltdown that led to above situation. First was some banks’ exposure to American financial institutions that went down as the sub-prime bubble bust in August-September 2007. These institutions were showing huge balances by the way of securitized housing mortgages. They kept on trading and borrowing on the strength of these assets which, in reality, were nothing short of financial maneuvering. When the bubble bust, these institutions were left with no real assets but just worthless paper money and huge debts to clear. They collapsed; some of them rescued by the American government. The Indian banks which had exposures in the fallen institutions pressed panic button while maintaining “all-is-well” public posture. But reports in media were scary. This confusion led to erosion of trust between banks and between customers/investors and banks. Banks stopped lending to each other as well as to businesses; customers started withdrawing their money/investment in banks throughout the world. There was massive liquidity crisis. Second was that while most central banks had immediately stepped in to check the financial avalanche, the RBI was reluctant to implement immediate measures to infuse liquidity fearing such measures would further hike the already high inflation rate at that point of time. The UPA government did not want that to happen when elections were round the corner. The RBI eventually did, or rather had to, implement measures to inject liquidity in the market but by that time it was too late. Third was the tumbling stock market. From the peak of 21000 in the middle of 2007, the stocks were experiencing a continuous and alarming downward slide. People were withdrawing their investment in equities. At the same time banks started hiking their deposit rates – as high as 11 percent in some cases- in order to create liquidity. Small investors who had opted out of their equity portfolios went for safe investment in term deposits with banks, particularly public sector banks. Now at this stage, the RBI started to reduce its various interest rates and urged banks to lower interest rates and start lending. But as said earlier the action came too late. The banks had already accepted massive amount in short- and long-term deposits at higher interest rates and, therefore, it was not possible for them to lend at lower interest rates, at least till the time such high-interest term deposits expire. If the RBI had acted earlier, this situation could have been awarded. It is precisely this situation that is ailing the Indian economy.
We will talk about what the government should do to reignite the economy in a separate article.
But this growth figure is on y-o-y basis. In a time of economic crisis like the one the world is facing today, it is important to monitor economic parameters more closely to avoid misplaced reassurance. If one looks at the third quarter in isolation and not on the
y-o-y basis, then the growth rate is actually zero! This implies that economic activities came to standstill. This has happened despite the Reserve Bank of India (RBI- India’s central bank) further reduced its lending and deposit rates for banks. The cut in lending rate should have encouraged banks to borrow from the RBI and cut in deposit rate should have discouraged banks from depositing their surplus funds with the RBI. Thus, the surplus funds should have gone to markets. But that is also not happening. Banks are not lending, being wary of creating bad assets. (ICICI bank’s chief Kamath has gone on record saying his bank would not give loans for two-wheeler purchase) Banks, both private and public sector, instead prefer to park their surplus liquidity with the RBI even though the interest rate offered is just 3.5 percent. As per an estimate, Indian banks have parked as much as 97 percent of their surplus liquid capital with the RBI. The resulting unavailability of credit is starving the economy.
There are several events before and in the aftermath of the global meltdown that led to above situation. First was some banks’ exposure to American financial institutions that went down as the sub-prime bubble bust in August-September 2007. These institutions were showing huge balances by the way of securitized housing mortgages. They kept on trading and borrowing on the strength of these assets which, in reality, were nothing short of financial maneuvering. When the bubble bust, these institutions were left with no real assets but just worthless paper money and huge debts to clear. They collapsed; some of them rescued by the American government. The Indian banks which had exposures in the fallen institutions pressed panic button while maintaining “all-is-well” public posture. But reports in media were scary. This confusion led to erosion of trust between banks and between customers/investors and banks. Banks stopped lending to each other as well as to businesses; customers started withdrawing their money/investment in banks throughout the world. There was massive liquidity crisis. Second was that while most central banks had immediately stepped in to check the financial avalanche, the RBI was reluctant to implement immediate measures to infuse liquidity fearing such measures would further hike the already high inflation rate at that point of time. The UPA government did not want that to happen when elections were round the corner. The RBI eventually did, or rather had to, implement measures to inject liquidity in the market but by that time it was too late. Third was the tumbling stock market. From the peak of 21000 in the middle of 2007, the stocks were experiencing a continuous and alarming downward slide. People were withdrawing their investment in equities. At the same time banks started hiking their deposit rates – as high as 11 percent in some cases- in order to create liquidity. Small investors who had opted out of their equity portfolios went for safe investment in term deposits with banks, particularly public sector banks. Now at this stage, the RBI started to reduce its various interest rates and urged banks to lower interest rates and start lending. But as said earlier the action came too late. The banks had already accepted massive amount in short- and long-term deposits at higher interest rates and, therefore, it was not possible for them to lend at lower interest rates, at least till the time such high-interest term deposits expire. If the RBI had acted earlier, this situation could have been awarded. It is precisely this situation that is ailing the Indian economy.
We will talk about what the government should do to reignite the economy in a separate article.
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