Economies grow based on production possibility prevalent in an economy. The different factors of production are traded off to get an optimal profit possibility on which investments are made. If these trade offs create large profit possibilities then economies grow at faster rate, other wise at slower rates. If there is large scale inflation then production possibility levels will decrease in the long run, being rise in inputs the cause.
When profit possibilities vanish economy goes into stagnation, otherwise it go on expanding at increasing pace, decreasing pace and stagnate. In layman terms such state of economies are called, boom time, normal times and bust times.
Reduction in interest rates
Any reduction in interest rates will be in contrast to what major central banks are trying to signal – a rise in borrowing costs- and could trip the Indian rupee which hit a 20-month high in April. This would be bad news for a country that needs to attract billions of dollars in foreign investments to make up a shortfall in domestic capital.
Foreign investment brings advance technology which improves productivity that leads to higher GDP. It also helps in job creation that leads to higher aggregate demand which supports more production of goods / service that means higher GDP. Foreign investment helps in gross capital formation which is very much essential for economic growth.
Falling Bank Loans
Demand for loans from sectors like infrastructure, food processing, basic metal, metal products and textiles all contracted.
The role of credit in stabilising the economy i.e controlling inflation and deflation.
INFLATION : To control inflation, the RBI tries to reduce the total credit. This is because an increase in credit will increase the quantity of money in economy and prices of all commodities will rise further increasing rate of inflation. To control inflation, RBI increases the rate of interest on loans and deposits and this favours saving, thus, controlling inflation.
DEFLATION : The reverse happens during deflation, we need to give more credit to boost investment. For this the central bank lowers the rate of interest on loans and deposits, this encourages consumption and discourages saving thus controlling deflation.
At this point of time, actual growth is lagging due to demonetization and high real interest rates. The upshot — a widening output gap that is pulling down inflation. The introduction of GST is likely to have a marginal impact on inflation. Some economists say price pressures may have eased further in June as businesses offered hefty discounts before the tax was implemented from July 1.
If the supply chains are normalised by September, growth is likely to see a sharp uptick due to the post-GST inventory restocking.