The demand-supply debate

The Indian Express     23rd May 2020     Save    
QEP Pocket Notes

ContextThe Union government is criticised for its neglect of the demand side and its excessive focus on the supply side and structural reforms, but there are problems with focusing on demand side too.

Demand-side proponents suggest: cash transfer, income tax cuts and cheap credit to consumer as supply side measures results in tepid credit growth, weak inflation, and flat wage growth.

Credit growth rate

  • Price of Credit: measured by Spread between lending rate and the funding rate (repo rate or deposit rates) for the banks. It reflects the risk premium banks charge to their customers.
  • Rising Credit Spread: 4% in 2018 to 6% in January 2020, also highlighted by the 2019 Economic Survey. But sluggish credit spread for public banks and to the MSME sector.
  • Rising spreads with lower credit volume will provide a clear sign that credit supply is broken.
  • Major issue with MSME sector: lack of credit availability rather than lack of demand for credit. 
  • Evident from: Change in definition of small firms led to increase in credit and subsequent investment in production by the firms newly covered by the priority sector lending.
  • Government approach of guaranteeing SME credit by resolving the risk sharing problem for banks will expand credit to credit starved SMEs at lower credit spread.

Consumer Demand

  • Direct transfers schemes are better than distortive subsidies. (Under Garib Kalyan yojana Rs 40000 crore has already been transferred.)
  • But PMJDY account balance has seen massive jump of Rs. 18000 crores during COVID-19. As consumer is less prone to spend at the time of uncertainty.
  • Boosting demand by providing cheap credit: not a good idea as an increase in household debt to GDP ratio leads to a sustained drop in future GDP, investments, and unemployment.

Way Forward

  • Reasonable risk-sharing principle: Risk should be borne by firms and Government rather than risk-averse consumer in employment uncertainty.
QEP Pocket Notes