Economics Internal Assessment – MacroeconomicsName of the article: “India to inject $32 Billion into State Banks to boost loan growth.”Source of the article: Bloomberg.comLink to the article: https://www.bloomberg.
com/news/articles/2017-10-24/india-to-inject-32-billion-to-bolster-capital-at-state-banksDate of publishing: 24.10.17Word Count: 743 The article discusses the capital injection accounting for $32 Billion into State Banks in India, aiming to boost loan growth and thereby stimulate economic activity, which is one of the key macroeconomic objectives. Referring to Diagram ?1, Indian economy is now at the equilibrium, where AD1=AS and as the article states “Indian economy slowed down for a fifth straight quarter”, which suggests that the economy is below the Economy’s Full Capacity of Output, hence in Negative Output Gap (NOG). Diagram ?1: Indian Economy – Short-Run versus Long-Run. Injection – is an increase in Government Spending (G) that aims to stimulate economic activity. Indian government plans to raise the funds for injection by issuing recapitalization bonds worth of ? 1.
35 billion, which will eventually help to reduce “stressed assets”, that comprise of bad loans and bonds made by banks. As the result, banks will have more liquidity, that will enable to increase loanable funds from Q1 to Q2, presented on Diagram ?2, consequently, lowering the interest rate, which is the price for borrowing money from, r1 to r2, thus providing “adequate credit for the deserving”.Diagram ?2: Injection – Interest RatesLower household and business indebtedness encourages Consumption (C) and Investment (I), that are the components of Aggregate Demand (AD), which is the total value of all goods and services demanded in the economy per time period. Combined with the additional “budgetary support”, worth of ? 760 billion, will shift AD curve from AD1 to AD2, raising the national output at all price levels from Y1 to Y2, shown on Diagram ?1. In fact, as AggregateuDemand approaches full employment, shown as Y3, any increase in AD will be inflationary without any increase in National Output. In fact, falling interest rates and increase in Aggregate Demand in the short-run, can return investors confidence, that have been “reluctant to buy shares of lenders plagued by profitability and asset-quality concerns”, hence boosting investments (I). Additionally, government “plans to spend $108 billion on building highways”, raising the mobility of factors of production, thus increasing productivity and boosting Long-Run Aggregate Supply, shifting it from AS1 to LRAS2 , shown on Diagram ?3.
Consequently, it creates spare capacity in the economy and reduces inflationary pressure, as the economy heads towards full employment.Diagram ?3: Increase of Aggregate SupplyIn fact, according to the Keynesian Multiplier Effect, any increase in injections results in an even greater increase in National Income. Therefore, depending on the potential size of the multiplier in terms of boosting growth, it may cause the economy to approach full capacity.
Referring back to Diagram ?1, it may create inflationary pressure on the economy as price level will increase from P2 to P3, without increasing the national output. However, it greatly depends on the Marginal Propensity to Consume (MPC), which is a measure of the proportion of each extra dollar of household income that is spent. Hence, if MPC is relatively small, meaning that people prefer to save the additional earnings, then the Keynesian Multiplier effect will not be as effective in contribution to economic growth and there are less chances of inflationary pressure, following the increase of AD.Moreover, it also depends on the relative size of Injections (J) made by the government, since for “Asia’s third-largest economy” it can be arguably small amount. Hence, the positive outcomes of injections, such as derived demand for employment, can remain unnoticeable. As interest rates fall – there is less short-term return on savings, which may cause the “hot money outflow”, resulting in depreciation of rupee against the foreign currencies, which is defined as a fall in value.
Combined with growing economy and rising inflation, as economy starts to reach full employment, it may discourage consumer spending, as well as willingness to borrow. Consequently, this may have a negative impact on Aggregate Demand, preventing it from reaching full employment. To conclude, the Fiscal Stimulus, in the form of increase of government spending on building highways, in combination with Monetary Stimulus, via banking system, might boost Aggregate Demand in the short-run and Aggregate Supply in the long-run, thus increasing national output, expanding spare capacity, hence reducing inflationary pressure. However, it greatly depends on Marginal Propensity to Consume and the relative size of the injection, which might reduce the effectiveness of government intervention. In fact, the positive aspects of the intervention, such as reduced Interest Rates, Derived Demand for Labour and positive impact on investors confidence, might still outweigh the risks, therefore the government should intervene. India to inject $32 Billion into State Banks to boost loan growth. India will inject 2.
11 trillion rupees ($32 billion) of capital into state-controlled lenders over two years, an amount that’s ten-fold higher than the government’s previous pledge as it seeks to revive growth in Asia’s third-largest economy.The government will sell 1.35 trillion rupees of recapitalization bonds while banks will raise another 760 billion rupees through “budgetary support” and from the markets, Rajiv Kumar, banking secretary at India’s Finance Ministry said at a briefing on Tuesday. The government also announced plans to spend $108 billion on building highways in the next five years.”The government is infusing this unprecedented amount to create bigger and stronger public sector banks and to ensure adequate credit for the deserving,” Kumar said. The record capital injection and plans to spend on building roads is Prime Minister Narendra Modi’s attempt to revive an economy that’s expanding at its slowest pace in three years. The new funds will help banks, that have been plagued by rising stressed asset ratio, revive lending growth from a 25-year low. Fitch Ratings Ltd.
estimates that India’s state lenders will need about $62 billion in additional capital by 2019 to meet global Basel III requirements. “The amount announced is considerably large and is good enough to solve the capital shortage at state-run banks to a large extent,” said Karthik Srinivasan, group head of financial sector ratings at ICRA Ltd., the local unit of Moody’s Investors Service. “This infusion will allow banks to take adequate haircuts on stressed accounts while cleaning-up the soured debt accounts.”Asset Quality:State-run lenders including Punjab National Bank and Bank of Baroda surged earlier on Tuesday on reports that the government was planning to increase capital injection in lenders. Punjab National surged 5.5 percent, the most since July.
Modi has been under pressure to act after opposition parties made the lack of job creation and slowing economic growth a key issue ahead of crucial state elections this year. India’s economy slowed for a fifth straight quarter in the period ended June 30 aggravating stressed assets at banks. India’s lenders have more than $182 billion of soured loans, the highest among the world’s largest economies.In February, while presenting the federal budget for the new fiscal year, Jaitley said that the government will spend at least 100 billion rupees buying shares of state-run lenders in the year to March 2018.
The government is forced to provide most of the equity capital that banks need because investors are reluctant to buy shares of lenders plagued by profitability and asset-quality concerns. The state banks’ scope to sell shares has also been curtailed by a rule requiring the government to own at least 51 percent of the lenders.The requirement has left some of the banks, which account for about 70 percent of India’s outstanding loans, historically less capitalized than privately owned peers, obliging the government to support them.
India’s cabinet on Tuesday also approved a plan to construct 83,677 kilometers of roads, highways and bridges in next five years with funding for the project coming from market borrowing, toll collections and federal budgetary support.Increased consumption is expected to boost the derived demand for labour in India, which has been lacking of “job creation”, according to the article. Referring to Diagrama?2, the derived demand for labour curve shifts from DL1 to DL2, and thus increasing the Real Wage Rate from W1 to W2, which may attract more labourforce, thus expanding the Supply (SL). In fact, as labour costs start to rise, this will increase the production costs, resulting in the rise of price level from P1 to P2, shown in Diagram ?1. Diagram ?2: Expansionary Monetary Policy – Job creation in India