Indian banks will offer cheaper loans to stimulate demand for two-wheelers and other consumer durables as Finance Minister P. Chidambaram tries to pull the economy out of the worst slowdown in a decade ahead of national elections due by next May.
Banks will get additional capital to carry out the plan, the finance ministry said in a statement on Wednesday after a meeting between Chidambaram and new Reserve Bank of India (RBI) chief Raghuram Rajan.
The move comes at a time when persistently high inflation coupled with shrinking employment opportunities in a slowing economy have crimped consumer demand.
Growth in consumer spending slowed down to 1.6 percent year-on-year in the quarter through June from 4.3 percent a year earlier, dragging down economic growth for the quarter to a near four year low of 4.4 percent.
"While this will bring relief to consumers, especially the middle class, it is also expected to give a boost to capacity addition, employment and production," the ministry said in a statement.
Unlike China, India is largely a domestic demand-driven economy. Robust consumer demand helped shield the economy from the worst of the global financial crisis in 2008.
The move is expected to boost the production of consumer durables items such as two-wheelers, refrigerators, washing machines and televisions, which has been hit by high interest rates and inflation. The sector has failed to register growth since last November.
"It is a short-term measure and can help to boost demand for the consumer durables and auto sector," said N.R. Bhanumurthy, an economist at National Institute of Public Finance and Policy (NIP), a Delhi-based think tank.
India's worsening economic slowdown is a major worry for Prime Minister Manmohan Singh's government as it seeks a third straight term in upcoming national elections.
Economic growth virtually halved in two years to 5 percent in the fiscal year that ended in this March - the lowest level in a decade - and some economists expect growth in 2013/14 to hit the lowest level since 1991/92.
That is nowhere near good enough for a country with India's demographics. It has a population of 1.2 billion and a per capita income of around $1,000.
Singh's government estimates the economy needs to be averaging 8 percent growth to generate jobs for the increasing numbers of youth joining the workforce.
The downturn has hurt the reputation of Singh, who was once hailed for unleashing the unprecedented economic boom of the past two decades. It has also allowed Narendra Modi-led opposition Bharatiya Janata Party (BJP) to gain momentum ahead of national elections.