Question

Use the following information to work.India's Economy Hits the Wall At the start of \(2008,\) India had an annual growth of 9 percent, huge consumer demand, and increasing investment. But by July 2008 , India had large government deficits and rising interest rates. Economic growth is expected to fall to 7 percent by the end of \(2008 .\) A Goldman Sachs report suggests that India needs to lower the government's deficit and raise educational achievement. With economic growth forecasted to slow, future incomes are expected to fall. If other things remain the same, how will the demand or supply of loanable funds in India change?

Short answer

The demand for loanable funds in India is expected to decrease.

Step-by-step solution

- Understand the economic context

We begin by understanding that India's economic growth is slowing down from 9% to 7% and that there are large deficits and rising interest rates. This generally means that future incomes are expected to fall.

- Define demand and supply of loanable funds

The demand for loanable funds refers to the desire of households and businesses to borrow funds for consumption and investment. The supply of loanable funds refers to the amount of savings available to be lent out.

- Analyze impact on demand for loanable funds

With economic growth slowing and future incomes expected to fall, businesses may anticipate lower profits, leading to a decrease in investment. Households may also reduce borrowing due to expected lower income, resulting in a decreased demand for loanable funds.

- Analyze impact on supply of loanable funds

Higher government deficits mean the government is borrowing more, likely reducing the available supply of loanable funds in the market. Additionally, if interest rates are rising, firms and households may decide to save more, slightly increasing the supply.

- Summarize effects on loanable funds market

Overall, the demand for loanable funds in India is expected to decrease due to slowing economic growth and expected future income declines. The supply might see minor changes but will largely be influenced by government's borrowing needs and higher interest rates.

Key concepts

loanable funds

The term 'loanable funds' represents the total amount of money available in the economy for households, businesses, and the government to borrow and invest. These funds primarily come from savings, which can be from private individuals, businesses, or other entities.
The demand for loanable funds arises when these entities need money for various expenses such as purchasing equipment, building infrastructure, or even for personal consumption. The supply of loanable funds, on the other hand, is made up of the savings that these same entities set aside.
In the context of India's economic situation in 2008, with consumer spending and investment on the decline, the demand for loanable funds is expected to decrease. Businesses may not see the potential returns from investments due to the forecasted slower economic growth, resulting in less borrowing. Similarly, households might be hesitant to take out loans if they anticipate lower future incomes.

economic growth

Economic growth refers to the increase in a country’s output of goods and services over time. It's often measured by the Gross Domestic Product (GDP). When an economy grows, there is more wealth creation, higher employment rates, and improved living standards.
In 2008, India was experiencing a slowdown in economic growth—from 9% at the start of the year to an expected 7% by year's end. Several factors can contribute to this slowdown, including reduced consumer demand, lower investment levels, rising interest rates, and significant government deficits.
Economic growth is crucial because it can lead to higher incomes and better standards of living. However, when growth slows down, as it did in India’s case, it can lead to increased unemployment, lower consumer confidence, and reduced business investment. This creates a challenging environment for sustained economic development.

government deficit

A government deficit occurs when a government spends more money than it receives in revenue. This can happen for various reasons, such as increased spending on public services, subsidies, or infrastructure projects, or due to lower tax revenues during an economic downturn.
In India’s case around 2008, large government deficits contributed to the economic challenges by necessitating more borrowing. This borrowing reduces the overall supply of loanable funds in the market because the government competes with private entities for these funds.
While running a deficit can be beneficial for stimulating the economy in the short term, consistently high deficits can lead to higher debt levels. This can increase interest rates, making borrowing more expensive for businesses and households, thus slowing economic growth further.

interest rates

Interest rates are the cost of borrowing money. They are crucial in the economy because they influence both the supply and demand for loanable funds. When interest rates are high, borrowing becomes more expensive, so people and businesses are less likely to take loans. Conversely, high interest rates can attract more savings, as the returns on savings accounts become more attractive.
In 2008, India experienced rising interest rates. This can have several effects: businesses may cut back on investment due to higher borrowing costs, and households might reduce consumption that requires financing, like buying homes or cars.
Additionally, high interest rates can compel the government to pay more on its debt, exacerbating the deficit issues. All these factors contribute to a context where economic growth can slow down, as seen in India during this period.