Explained | Reasons behind moves by Nirmala Sitharaman and RBI

Nirmala Sitharaman
Finance Minister Nirmala Sitharaman. (File Photo: IANS)

When India's Finance Minister Nirmala Sitharaman announced a slew of economic reforms last Friday, India Inc heaved a huge sigh of relief. And expectedly enough, BSE benchmark Sensex skyrocketed 793 points on Monday.

But when the Reserve Bank of India, with its long standing reputation of parsimony, decided to transfer a surplus fund of Rs 176,000 crore to the India government, many were taken aback.

So, why did the government force the autonomous central bank to forego its most valued surplus reserve in a clear departure from tradition? And why did the NDA government decide to go back on its tracks and erase the lines etched on its prestigious budget almost 50 days after it was presented?

One of the major reasons for the quick reversal in policy is indubitably the flight of Foreign Institutional Investment (FII) fund from the country following the tax-surcharge on super-rich, including non-corporate foreign entities.

In July and August alone, Rs 29,263 crore (net outflow) of FII left the country. Compare this to Rs 688 crore and Rs 2135 crore net outflow in June and May respectively and the positive net purchase of Rs 32,371.43 crore in March.

A foreign institutional investor (FII) is an investor or investment fund registered in a country outside of the one in which it is investing. These investors, usually hedge funds, insurance companies, mutual funds and investment banks invest a considerable amount in developing economies due to higher returns.

Secondly, the slowdown of the economy played a seminal role in triggering the negative sentiments. The Indian economy hit a five-year-low of 6.8 per cent in FY19. With 5.8 per cent, the economy hit the lowest growth rate in 20 quarters in the January-March quarter. The Monetary Policy Committee (MPC), the Reserve Bank of India's (RBI) body for fixing interest rates, had also lowered its growth forecast by 10 basis points in June.

The lay-offs by companies dealing with basic commodities, automobiles sector and services – Parle-G, HSBC bank, Mahindra and Mahindra to name a few—indicate that these figures were not merely on paper. They are disturbingly real.

Thirdly, the huge bad debt incurred by the banking sector is crippling the economy on a day-to-day basis. The colossal Non-Performing Assets (NPA) of banks are acting as a severe restraint on the economy. As per RBI provisional data on global operations, the aggregate amount of gross NPAs of public sector banks and scheduled commercial banks (SCBs) were Rs 8,06,412 crore and Rs 9,49,279 crore respectively on March 31, 2019.

The witch-hunt on high profile individuals for alleged tax evading, money laundering and so forth – Cafe Coffee Day's Siddhartha, former finance minister P Chidambaram, lawyer Indira Jaising to name a few – has also sent a wave of panic across business circles.

In this context, the desperate effort by the Finance Ministry to help the sinking economy comes in as no surprise.

The decision to exempt foreign investors and domestic investors from the super-rich tax has to some extent revived the animal spirits in the market. The assurance that violation of Corporate Social Responsibility (CSR) will no longer be a criminal offence also aided in reviving the bullish sentiments. The stock-market indices are reflective of this fact. Animal spirits describe how people arrive at financial decisions, including buying and selling securities, in times of economic stress or uncertainty.

The infusion of Rs 70,000 crore into the economy through PSBs is expected to provide a much needed impetus to the struggling banking sector. This credit infusion is expected to revive demand and eventually uplift the economy through a multiplier effect where a large stimulus will revive demand and cause a larger change in the supply or output.

RBI Governor
RBI Governor, Shaktikanta Das

The heavily affected auto-industry also heaved a sigh of relief this time round. The vehicles purchased till March 2020 will get the benefit of 30 per cent depreciation as opposed to 15 per cent earlier. The stimulus to PSBs and indirectly NBFCs is also expected to resurrect the demand for automobiles. NBFCs are the most significant source of vehicle loans for the common man.

Other significant moves such as removal of angel tax for start-ups – a kind of direct tax that the receiver (start-up) of the fund from an angel investor has to pay – will also prove to be major driver in the economy.

While devastated India Inc is beginning to look up following Sitharaman's announcements, what is essentially missing in the main budget, mini-budget and the general economic policy at large is the failure to induce demand from below.

Desperately hoping for a trickle-down-effect – a top-bottom-approach – to work after stimulating the supply side of the economy may not be enough to fuel the economy in the long run.

Focussing on the demand side of the economy – the unemployment situation (which is at a 45-year-high of 6.1 per cent), the minimum wage conundrum, the public distribution system – is also essential to address the looming crisis faced by the Indian economy.

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