A centre leader for a microfinance company. (Photographer: Adeel Halim/Bloomberg)

Cash Constrained, Does The Economy Need Credit Stimulus?

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Cash is in short supply. For you and me. But also for small businesses.

The government’s decision to scrap notes of Rs 500 and Rs 1000 denomination, and restrict cash withdrawals in the short term, has meant that even daily cash needs are tough to meet. Cash withdrawals are limited to Rs 24,000 per week, according to the prevailing rules announced by the government.

The resultant cash squeeze has meant that consumers and businesses are having to hold back on expenses, be it salaries or purchase of raw materials. On Monday, BloombergQuint reported that a host of businesses - from transporters to clothing manufacturers, are being forced to restrict operations to deal with the cash crunch. This, in turn, could lead to a demand shock and a decline in growth rates for the economy.

The expectation of a demand shock has prompted many to call for an interest rate cut by the Reserve Bank of India (RBI). Another rate cut, however, may not be the solution to a cash-crunch driven slowdown.

An alternative could be to push the financial sector, particularly non banking financial companies (NBFCs), to disburse more credit. The idea, essentially, would be to provide credit stimulus to the economy.

NBFCs, which are active lenders to small and medium sized businesses, could be incentivized to lend more to these businesses to dull the economic impact of the cash crunch. One way to do this would be for RBI to open a refinancing window for NBFCs to support increased lending.

NBFCs are at the ground level and are in more direct contact with customers and small businesses than banks....If you put credit lines or refinancing arrangements in place, it will be easier for NBFCs to lend. 
Hemant Kanoria, Chairman and Managing Director, Srei Infrastructure Finance

When asked whether there was any sign of an increase in demand for credit in light of the cash shortage, Kanoria said that people are “still coming to terms” with the impact on their daily lives.

Bindu Ananth, chair of the IFMR Trust - a financial inclusion platform, says that credit stimulus would be a “luxury” but added that the more immediate need is for liquidity. Microfinance NBFCs (MFI-NBFCs), in particular, are not being able to collect what is outstanding, which means they cannot disburse, she said while adding that the liquidity crunch needs to be alleviated at the earliest.

Collection and disbursement for MFI-NBFCs has come to a complete halt and this has a big impact on the informal sector...There needs to be some way for NBFCs to collect on repayments so that flow of credit to customers can restart.
Bindu Ananth, Chair, IFMR Trust

Also Read: Big Businesses Urge Government To Enhance Overdraft Limits To Fight Cash, Working Capital Crunch

Restore Money Supply Within Days Not Weeks

A number of senior economists, who are also familiar with the functioning of the central bank, said that it is essential to restore the supply of money at the earliest.

Money supply should be restored within days not weeks to limit the needless damage to the economy, said one of the people quoted above while requesting anonymity due to the sensitivity of the issue.

A second person noted that the logistics of the operation are daunting and some disruption is inevitable. GDP growth will be impacted in the short term and the way to reduce the impact would be through credit stimulus, said this person on the condition on anonymity. A measure, such as opening a refinance window, would impart confidence even if it is not used, said this person.

According to Arvind Virmani, former chief economic advisor to the Indian government, the immediate impact would flow through the channel of transactions.

”The more dramatic impact would be felt on retail trade and retail activity, including daily wage labour, for a week or two. After that, gradually, atleast in the metros, cash supply would increase but in the rural areas it may take longer. So the question is how widely and how quickly the currency is replaced in the transactional system,” said Virmani.

When asked about whether credit stimulus would work to ease the pain, Virmani said that is one of the measures being suggested by industry representatives to the government. In particular, stimulus could be channeled through the housing finance sector, which could see an increase in demand if real estate prices drop as a consequence of the government’s clamp down on black money.

“..If you look at housing finance, for instance, you should set policies to ease housing finance to allow middle-income consumers to buy homes. If they were in the process of doing this, help them accelerate the process. Also, if possible, add new measures along the lines of refinance facilities. This will help ensure that this recovery is not delayed.
Arvind Virmani, Former Chief Economic Advisor, Government of India

What will aid this process is the decline in interest rates. As banking sector deposits have surged following the government’s decision to withdraw Rs 500 and Rs 1000 notes, rates have dropped. The 10-year benchmark bond yield has dropped to 6.53 percent from 6.83 percent before the announcement. Bank deposit rates have also started to ease, which, in turn could bring down lending rates.

Also Read: Banks Park Rs 1.67 Lakh Crore In Excess Cash With The RBI

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