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Desperate measures: Chidu-Rajan's demand booster dose is hardly enough

Desperate times call for desperate measures. Or so it would seem, from the government's latest move on providing a selective stimulus to generate greater demand for some sectors. The government hopes that the selective stimulus program would help spur capacity, generate greater employment and production and eventually push the sputtering growth rate.

Predictably, some sections of industry and some analysts have welcomed the government's move which is going to be undertaken by pumping in higher capital to public sector banks - greater than the budgeted Rs 14,000 crore - and getting them to lend to the select sectors at lower interest rates. The sectors TVs, refrigerators, motorcycles and scooters.

 Desperate measures: Chidu-Rajans demand booster dose is hardly enough

With elections round the corner, the government is trying to push growth and spur demand by way of selective stimulus. But these are wrong signals. Reuters

The keenness of the government to intervene in the banking system is fraught with risks, and is bad economics. Finance minister Palaniappan Chidambaram has said he would now meet PSB heads to impress upon them the need to give cheaper loans to these select sectors. The decision to push through this stimulus came after a meeting the Finance Minister had with Reserve Bank of India (RBI) governor Raghuram Rajan.

The selective stimulus program, coming just before the festive season, rides on the expectation that the lower rates would prompt greater demand and lead to a growth momentum. But coming as it does with elections in five states around the corner, the move is also bound to be viewed as political and populist in many circles. But more than that, there is little guarantee, given that there are no real details of the scheme available yet, what the efficacy of this booster dose will be.

The most important flaw is that it surely can't be the government's business to get into forcing banks to lower interest rates.

While some economists feel that the scheme would work, others are not so sure. Indranil Pan, chief economist at Kotak Mahindra Bank, for instance, feels this move can only lead to price distortions. "Any move like this is bound to lead to distortions in pricing," says Pan, adding that unless demand contracts, it would be tough to correct the current account deficit and that would impact the currency and eventually inflation.

More importantly, whether the move will actually generate greater demand, for instance, for two-wheelers is debatable. Sales of automobiles and two-wheelers depends on present and future income generation. Oil prices are also another major factor, and the interest rate can only be an enabler. It can hardly be the driver of such demand, feels Pan.

Pravin Shah, CEO of Mahindra & Mahindra's automotive division, feels the government's move can at best be a 'feel good factor' in the festive season, and may help the fence sitters take a call on buying two-wheelers. "In these difficult times, any sop is welcome. It is a good move, but more a feel-good factor," says Shah.

Industry sources are of the view that when a buyer takes the decision to go for a two-wheeler and goes for a 36 to 48-month equated monthly installments (EMI) scheme, banks lowering or not increasing rates will have little impact particularly when RBI has raised repo rates and manufacturers have hiked their selling prices higher than the increase in costs.

The best case scenario is the move would be a sentiment booster for the festive season, but its sustainability as a move to push growth is in serious doubt. Adds Pan: "Timing wise, this move is perfect. But the issue is whether it will be sustainable beyond Diwali." There are no clear answers to that question.

Analysts also point out that the move is also aimed at generating brownie points, at a time when growth is falling and inflation is on the rise. For any government cornered by these factors, this move is an act of desperation to bring some semblance of feel-good back.

The consumption scenario has clearly been a problem, and the government's desperate attempt to boost demand comes in that context. Says a CRISIL report: "Over the past few quarters, consumer spending has declined significantly - growth of privatehousehold consumption expenditure dipped to a five-year low of 1.6 percent in Q1FY14.

Persistently weak economic activity, as indicated by weak IIP data, and high inflation are responsible for the moderation in consumer demand. As per CRISIL Research, the decline in spending is more severe in urban than in rural India. Going ahead, we expect rural consumption to improve following good monsoons coupled with government spending in social benefit programs; urban spending is expected to remain weak."

With the selective stimulus, Chidambaram will be hoping to turn the tide. But what is bound to send confusing signals is that the RBI, which only recently raised the repo rate by 25 basis points to send a signal that it was keen to fight inflation, has joined hands with the government to push the selective stimulus scheme.

Only the details of the scheme and the level of additional capitalization for banks will determine how this latest move plays out. The next few weeks will prove whether the stimulus indeed has legs.

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Updated Date: Dec 21, 2014 00:35:36 IST