Cutting policy rates won’t revive the economy
Economic recovery will only happen through revival in aggregate demandUpdated: Aug 07, 2019 17:38 IST
The Indian economy is in the midst of a slowdown. There is reason to believe that this is not just a cyclical phenomenon. The most significant pointer to this is that, including today, the Reserve Bank of India has reduced policy rates four times since February. The cumulative year to date reduction is 110 basis points. One basis point is one hundredth of a percentage point.
In an ideal world, lowering interest rates should stimulate economic activity. However, every rate cut decision has also been accompanied by a downward revision of expected GDP growth rate for the current fiscal year. The year-to-date cumulative reduction in expected GDP growth is 50 basis points. Today’s monetary policy resolution notes that high frequency indicators suggest a further weakening of both domestic and external demand conditions. It is futile to believe that just cutting policy rates is going to revive economic activity anymore. So what is to be done?
A sustained economic recovery has to come via a revival in aggregate demand. Any policy intervention which seeks to do this has to first understand the reasons behind a slowdown in demand, including formalisation The current government has pursued an aggressive formalisation of the Indian economy through policies such as demonetisation and the Goods and Services Tax (GST). This is likely to have forced businesses to come under the tax radar.A large addition to both the direct and indirect tax payer base supports this claim. However, a lot of such businesses might have lost or squeezed their viability in doing so. This could have given a permanent negative shock to aggregate demand in the economy.
These policy changes cannot be undone anymore. This leaves economic policymakers with two options. They should either find ways to compensate those who were running erstwhile unaccounted economic activity for the squeeze in their incomes, or accept lower growth levels as the new normal for the Indian economy.
First Published: Aug 07, 2019 17:38 IST