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Government Stimulus and The Problem of Excess Liquidity

Its been around four months since the world had found its first COVID-19 case in the city of Wuhan, China. Till now we have witnessed around 3 lakhs deaths and a huge loss to the world economy. UN has predicted that the global economy could shrink to 1% in 2020 from an earlier forecast of 2.5%. Almost every country in the world is in virtual lockdown. Businesses, saloon, restaurants and industries are shut to contain the spread of the virus. Government and Central banks around the world are deploying every measure to sustain the economy in this time of crisis. Most the nations have announced stimulus package for their country to mitigate the effect of coronavirus, Germany leading the race by announcing package which is 60% of its GDP output. India is also severely affected by this netherworld virus with an estimated loss of Rs. 1400 crores in just 47 days of nationwide lockdown. Unemployment, as reported by CMIE (Centre for Monitoring Indian Economy) on 3rd May, have shot up to the level of 27% far above 7% which is reported before the start of lockdown. Though lockdown was necessary it hit hard on the small businesses and industries. Rating agency Moody's expect 0% growth Indian GDP in the fiscal year 2021. Many steps are taken by the government and Reserve bank of India to boost the liquidity and keep the economy afloat. Many economists are saying these measures are not enough for the crisis which clenched the 3 trillion dollars Indian economy. Indian Government has announced a stimulus package Rs. 1.7 lakh crores for the citizens of India, which is merely 0.8 per cent of the Indian GDP compared to the 10 per cent of GDP stimulus announced by the US. India is expecting another stimulus package which can cushion the economy a bit and for this stimulus package, Indian respites its hope on borrowed money as the government is earning little to no revenue from stalled businesses and industries. On Friday after the market hours, the government announced the revision of its 20-21 borrowing programme by 54% to Rs. 12 trillion from Rs. 7.8 trillion estimated earlier. This is good for the large stimulus but it can shot up the Indian debt to 75 - 80% of the GDP which is already at 70 %. This is not good for the credit rating of India. Country credit rating is important for everyone as oversea borrowing for firms and government get costlier if rating deteriorates. Already S&P and Fitch rating for India is BBB- which is just one notch above the junk category while Moody's has lowered the Indian rating outlook to negative in November 2019. On the other hand, RBI has cut repo rates and performed many monetary operations to revive already sick financial markets but all the measure by the RBI are focused towards the infusing liquidity in the banking sector. While RBI focuses on the liquidity, the fundamental problem with the Indian Economy is risk aversion and lending pause. NBFCs (Non-Banking Finance Company) crisis of 2018-19 had jittered the financial sector and after that banks are not confident in lending the money to low rating entities. It is not surprising that Targeted LTRO 2.0 by RBI failed which focuses on lending to the NBFCs by the banks at 4.4%. Banks have been parking around Rs. 8.42 trillion of excess liquidity in the reserve bank (on 4th May 2020). Why a bank is going to lend to low credit NBFC when it can securely park money with RBI at 3.75 per cent? RBI have a range of options to discourage the banks from keeping their funds sitting idle. It can cap the amount of money which a bank can keep with the RBI or can create a standing deposit facility by which RBI can absorb excess liquidity at a rate lower than the current reverse repo which is 3.75% which can give a boost to lending and eventually a kick to the economy. For reducing risk aversion RBI and the government have to take the steps for the credit enhancement of the loans given to the MSMEs and NBFCs with low credit ratings. Also, Credit guarantees can be provided by the government to banks for giving loans to micro, small and medium enterprises(MSMEs) like it had done with the NBFCs loans. The growth story of India can only be restarted from rural India by strengthening the small enterprises and providing them with enough support from the government.


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