The Hindu Business Line : Another dose

One aspect of the current liquidity crunch that ought to be clear is that it may not remain just a liquidity crunch. Like its counterpart in the West, it may evolve into a systemic crisis of confidence that could substantially slow down the economy’s growth. The problem seemed to have surfaced with the mass and rapid exodus of moneys brought in by foreign institutional investors and the consequent fall in the equity market. But that phenomenon simply foreshadows the more endemic problem of falling domestic demand and investments occasioned by rising cost, itself a result of not just global inflation but domestic food shortages and high interest rates to begin with. So, when the RBI lowers the Cash Reserve Ratio for the third time within a month, it is slaking a temporary thirst for funds in the banking system. The reduction releases another Rs 40,000 crore, on top of the Rs 60,000 crore from earlier cuts. With lending rates still the highest in five years, in these uncertain times however, both consumers and producers will find borrowing an exacting business and the next two quarters may witness sluggish credit offtake.

It would be wrong to assume that the liquidity issue is similar to that in the G-7 countries, where federal funds would let banks stream credit into parched economies. In India, banks had enough funds till last month but credit has been getting progressively dearer and scarcer for a large number of consumers initially and now for producers. So long as the latter could borrow at very low rates from flush global markets, the cost of domestic credit didn’t seem to matter. Then came the collapse of investment banks, liquidity dried up and the options narrowed. But domestic credit is expensive; since consumers may still shy away, producers will hesitate before committing fresh investments. In effect, the economy will gridlock into a vicious circle of declining consumer and investment demand. As if that were not enough, the world economy’s slide into recession that will hurt export demand transfers an additional burden on the domestic economy.

This is the greatest economic challenge the UPA government has ever faced so far, and the best opportunity yet to showcase its vision of the big picture. Having quickly cranked up the monetary instruments, the government must now ready both fiscal and public policy measures to revive consumer and investment demand should private investment fall off; core sector companies must be helped to seek bilateral and multilateral funding for their projects that will languish for want of private capital in the currently dry winter. And interest rates must fall to a level attractive for both producers and consumers to meet once again in a reviving market.

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