Q.(a) Elucidate the Loanable Funds Theory of Interest.

(a) The Loanable Funds Theory fixes the interest rate by the demand for and supply of loanable funds, improving on the classical view by adding bank money and hoarding. (b) India's economy is strong because of its size and growth, demographic dividend, resources, agriculture, services/IT strength, large market, high savings and sound financial system.

(a) Loanable Funds Theory of Interest

The Loanable Funds Theory is a neo-classical theory associated with Wicksell, Robertson and Ohlin. It holds that the rate of interest is determined by the demand for and supply of loanable funds in the money market.

Demand for loanable funds comes from:

• Investment (I) — firms borrowing to buy capital goods (the main source).
• Hoarding (H) — the desire to hold idle cash balances.
• Dissaving / consumption — borrowing for present consumption.

Supply of loanable funds comes from:

• Savings (S) — out of current income (households and business).
• Bank credit / newly created money (M).
• Dishoarding (DH) — releasing previously idle cash.
• Disinvestment — funds released when worn-out capital is not replaced.

The equilibrium rate of interest is fixed where total demand for loanable funds equals total supply. This theory is more realistic than the classical (real) theory because it includes bank money and hoarding, not just saving and investment; however, it is criticised as indeterminate because saving itself depends on the level of income.

Diagram (in words): A downward-sloping demand-for-loanable-funds curve and an upward-sloping supply curve intersect; the interest rate at the intersection is the equilibrium rate.

(b) Strong features of the Indian economy

• Large and fast-growing economy — among the largest and fastest-growing major economies in the world.
• Huge and young population — a large workforce and a demographic dividend, plus a vast domestic market.
• Abundant natural resources — fertile land, minerals, forests, varied climate. …