Indian Consumers in Distress

The Reserve Bank of India (RBI) blinked in its standoff with the Indian finance minister P Chidambaram. The Indian central bank lowered the rate at which it lends to banks by a quarter of a percentage point and also reduced the amount of funds that the banks have to keep with it by the same amount on the last Tuesday of January.

The Indian finance minister had been indirectly blaming the RBI chief Duvvuri Subbarao for the nation’s sputtering economy refusing to pick speed again. The monetary policy confrontation had also resulted in Subir Gokarn not getting an extension as RBI deputy governor.

North Block’s reasoning is that if RBI loweredits repo rate it will lead to bank loans costing less and result in individuals and companies spending more. This chain of thought turns a blind eye to loan restructuring and defaults, such as by Vijay Mallya’s Kingfisher Airlines, hurting banks and the economy. It is a case of robbing Peter to pay Paul. Banks must slash deposit rates if they are to make loans cheaper. This discourages prudent households from saving but keeps funding imprudent business ideas such as Kingfisher with cheap money.

The Indian consumer had been bailing out the spendthrift government and keeping the economy from collapsing. But now even he is losing hope. The first signs were evident when India’s net household financial savings hit a 22-year low of 7.8 percent of the GDP in 2011-12. It is getting increasingly clear that years of high inflation are taking a toll on private consumers. This just adds to the bad news for India’s growth story.

RBI’s December consumer confidence survey found Indians getting pessimistic about economic conditions, household circumstances and spending.

These are not just alarm bells but may even be death knell for Chidambaram’s hopes that cheaper loans will make Indians loosen purse strings.

The numbers also tells us that while consumer demand continues to fuel India’s growth, it is losing pace.

The war on inflation too seems to be going nowhere. Not only is consumer price inflation still in double digits, the burden on the common man is heavier than the data show. The inflation and prices are set to rise further as the prices of diesel are now going to be increased every month.

Raghuram Rajan, professor of finance at the University Of Chicago Booth School Of Business and the chief economic adviser in India’s finance ministry, recently wrote in the context of advanced countries: “The worst thing that governments can do is to stand in the way by propping up unviable firms or by sustaining demand in unviable industries through easy credit.”

Investments have fallen, exports are stumbling. The government cannot spend its way out of this slowdown. Especially as tax collections are under strain and there is pressure to cut fiscal deficit.

Hopefully, Chidambaram will listen to his adviser and not force banks to cut rates and lend to companies which may default tomorrow. With national elections due next year, he must ensure that the government is not arm-twisted by his party into going on a populist spending binge.

by Ashutosh Misra

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