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MOSL: FUEL OR ENGINES (ECONOMY)-Will massive monetary easing stimulate the economy? Or will it be counterproductive?

FUEL OR ENGINES (ECONOMY): Will massive monetary easing stimulate the economy? Or will it be counterproductive?

 

• Notwithstanding massive buying of government securities by the Reserve Bank of India (RBI) in FY19 and interest rate cuts of more than 100 basis points (bp) in CY19 (with expectations of further cuts of 40-65bp over the next six months), demand for massive/deeper monetary stimulus has become louder. In this note, we argue that further monetary easing in India could be counterproductive.
• We believe that household savings (in the form of bank deposits, ~50% of their financial savings) are strongly correlated with nominal deposit rates, which, in turn, are strongly affected by the policy repo rate. Lower and falling nominal rates could explain lower and falling household savings, notwithstanding rising and higher real deposit rates. Further, while corporate and government investments have grown decently over the past many years, household investments (or real estate) are the key drag on economic growth. The latter, in our view, is actually affected by household income rather than interest rates.
• Overall, further monetary easing is likely to hurt financial savings and unlikely to affect household investments (or physical savings), which imply that private consumption could get a boost. As we have argued , faster growth in consumption than income over the past few years for the first time in the post-independence history has led to a sharp fall in household savings and spurt in household debt. These characteristics of the Indian household sector have made current economic growth very vulnerable and unsustainable. Consequently, we argue that the authorities will need to make thorough considerations before encouraging consumption (and/or debt) and discouraging savings because while these measures could prop up economic growth in the short run, the long-run consequences could be multifold and highly adverse.