Why Liquidity is must for an Economy?
In last article, "Solution to Environmental Crisis", we learned how India is tackling the environmental crisis and contributing in improving the green environment.
No doubt, the collection of Goods and Services Tax (GST) is boosting the Indian Economy but due to impact of Covid-19 all around the world and also in India, there is huge downward trend in demand of Goods and Services. The economies of high scale production of Goods is no more for the industries and the cost of manpower also have increased. The organizations which have used Work From Home in their recruitment process and realized talented people to work from distance; have been benefited. There is need to increase the liquidity for increasing the demand, which will create employment opportunities in India. Let's understand it in detail.
Money and Banking:
The central bank of an economy ensures that the economy should have
enough liquidity for smooth functioning of the financial transactions in the
economy. The central bank also ensures that the banks should not have large
number of stressed assets and for this purpose, the bank’s capital requirement
norms are set up and monitored. The capital requirement norms are particularly
to cover up the expected losses of the bank, in case, it failed to manage its
business by providing credit to the suitable persons and organizations. The
central banks assess the minimum capital requirement very carefully on the
basis of cumulative default rates (CDRs) of the banks. In India, the RBI found
that during 2017-18, the gross NPA (Non Performing Assets) ratio of public sector banks reached 14.6%
and sensitized banking organizations to reduce the ratio. The liquidity crisis
can harm the whole economy and it usually happen whenever there is increase in
the NPA ratio or whenever the loan defaulter’s amount becomes very large.
What refers to Liquidity for an Economy?
An investor always prefers to invest in those instruments which can be
liquidated at the time of his need. The liquidity is the ability by which a
person can convert any asset into cash quickly. In India, during second quarter
of financial year 2018-19, the rupee showed significant fall in its value and
the nation faced critical situation with rising prices of crude oil and prices
of petroleum prices (in terms of dollars). The Reserve Bank of India intervened
and sold dollars to improve the situation. Apart from it, the RBI also sold the
bonds to increase the demand of rupee in overseas. These efforts had been taken
to tackle two problems, first to appreciate the value of money in rupee and
second to improve the liquidity in the economy which had reduced due to
IL&FS crisis.
How Central Bank controls liquidity in an economy?
A crisis becomes worse when it brings chain impacts, in case of
IL&FS the non finance banking companies (NBFCs) affected with lack of
liquidity. One default in payment of loan, is not much stressful, it becomes stressful when there are defaults one after another, as happened in case of
IL&FS. Even the IL&FS Financial Services defaulted for Rs. 440.46
crores up to the mid of September, 2018. Due to failure of IL&FS to perform
in the housing sector, the banks stopped providing loans to all housing sector
companies and even to the infrastructure companies. It led to less financing to
infrastructure and housing sector, leading to higher rate of interests also
particularly for this sector. In case, the sector is not recovered from this
zone of lack of liquidity, the next sector it may impact is Auto sector
including two-wheeler and trucks because most of the NBFCs finance the needs
of Auto sector.
In order to control and maintain liquidity in an economy, the banks are forced
to make provisions. In India, the RBI (central bank of India) asked banks to
tackle crisis of NPAs by making enough provisions so that the economy not
suffered significantly due to any crisis..... to be continued... (How India Tackled IL&FS Crisis...)Liquidity and Covid Pandemic:
During pandemic of Corona Covid-19, it is observed by me that due to lack of liquidity, gold prices come downwards from Rs. 50,000 to Rs. 43,000 during the time, the Covid cases increased in India. And even it is observed that with downfall in Gold, the prices of Crude oil went up. This all happened due to liquidity in Indian economy shifting from one sector to another for better returns on investments.
*Copyright © 2018 Dr. Lalit Kumar. All rights
reserved.
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