Indian five hundred rupee currency notes. Image: iStock

India’s central bank cut its key lending rate from 4.4% to 4%, the lowest level ever, in a surprise move that underscores the severity of the nation’s gathering economic crisis.

The Reserve Bank of India (RBI) said the pandemic was damaging the economy more severely than initially anticipated and that the economy would contract over the 2020-21 fiscal period.

The RBI also allowed lenders to extend an ongoing moratorium on loan repayments by another three months. The initial moratorium was due to end on May 31.

Economists, credit assessors and securities firms have all predict flat or negative growth for the year, which if accurate will mark India’s first economic contraction in four decades.

The RBI said the biggest impact from the pandemic had been on private consumption, which accounts for about 60% of domestic demand. 

India imposed a countrywide lockdown on March 25 to contain the virus, a Covid-19 quarantine that has shut down vast swathes of the economy and displaced millions of workers.

The lockdown has severely crimped demand, production and investment, while workers and daily earners who constitute more than three-fourths of India’s 1.38 billion population have reportedly been the worst affected. 

The government has relaxed some restrictions for agriculture and related activities in rural areas and districts with no positive Covid-19 cases.

However, economic activity is still largely crippled as the top six most industrialized states that account for 60% of industrial output are still shuttered as more severely hit Covid-19 “red” and “orange” zones. 

“High frequency indicators point to a collapse in demand beginning March 2020 across both urban and rural segments,” RBI governor Shaktikanta Das said after an unscheduled monetary policy committee meeting on May 22.

“Electricity consumption has plunged, while both investment activity and private consumption suffered precipitous declines, as reflected in the collapse in capital goods production and the large retrenchment in the output of consumer durables and non-durables in March.’’ 

Key consumption indicators including car and truck sales and domestic air travel and tourism have been contracting since March. The country’s biggest car maker Maruti Suzuki reported a 28% drop in profits in the quarter ended March.

External trade is also down almost 60%; the Finance Ministry was previously projecting 2-3% growth for the financial year

Economists and businessmen, however, don’t expect record low interest rates to solve the quagmire. Even after the 40 basis point rate cut, the benchmark 10-year government bond yield fell only 7 basis points on Friday’s announcement.

Repo rate cuts of 210 basis points so far this year have resulted in banks lowering rates by only 80 basis points, underscoring the dire state of the sector.

The biggest economic problem today isn’t the level of policy rates or liquidity, but rather elevated credit risks, Sonal Varma, analyst with Nomura Securites wrote in a report.

Weak financial sector balance sheets will likely increase risk aversion among lenders, thwart policy transmission and may remain a medium-term growth headwind, even under a scenario of low policy rates and excess liquidity, the report said. 

Nomura Securities and Goldman Sachs predict the economy will contract by more than 5% in the full year to March. Most banks are saddled with bad loans and are extremely reluctant to lend, thus negating the efficacy of a rate cut, analysts say. 

“The crux of the economic recovery hinges on increasing demand at a macro level. Monetary easing alone will not yield the desired outcomes,’’ says Sanjay Kumar, chief executive of Elior India.

“The consuming class in India is essentially the taxpayers and hence, reducing taxes on consumption and income will not only stimulate demand but also help kick start the revival of key sectors like food, automobile and real estate,” he said.

The Indian economy was already slipping before Covid-19. Last year, gross domestic product (GDP) growth slipped to 4.7% from about 8% five years earlier.

Former RBI governor Raghuram Rajan said in an interview with news portal The Wire that reviving the construction sector and pushing ahead forcefully with infrastructure development was key to recovery.

The Federation of India Chambers of Commerce and Industry said the government and RBI need to focus on reviving the most battered sectors such as airlines, airport developers, hotels, travel, tourism, retail and healthcare sectors.

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