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Source: The Hindu
Synopsis: Unless policy action ensures higher demand and growth, India will continue on the path of a K-shaped recovery
Background
- Some economists are of the opinion that the Government should not intervene with the economy and that it will revive by itself.
- These economists’ reason that, like after the Great Depression, the economy rebounded worldwide, and so will it with us.
- However, such arguments are fallacious on four accounts
Why government intervention is needed for Economic recovery?
The first factor, demand.
- In the case of the Great Depression, demand was created by the Second World War effort.
- In the current scenario, there is no war to create demand.
- Further, the COVID-19 pandemic has resulted in demand destruction as confirmed in the Centre for Monitoring Indian Economy and other surveys.
- To counter demand destruction the western world has spent a lot of money stimulating the economy.
- Rising freight costs, non-availability of containers and a strong rupee relative to major competitors is hampering India’s growth exports to Western countries where demand has been generated.
Second factor is the rising inflation accompanied by stagnant growth.
- India is suffering from stagnant growth to low growth in the last two quarters along with rise in inflation
- Causes of Rising Inflation
- One, high asset price inflation caused by ultra-loose monetary policy followed across the globe.
- Foreign portfolio investors have directed a portion of the liquidity towards our markets.
- Compared to a developed capital market such as that of the U.S., India has a relatively low market capitalisation.
- It, therefore, cannot absorb the enormous capital inflow without asset prices inflating.
- Two, supply chain bottlenecks have contributed to the inflation. Essential goods have increased in cost due to scarce supply because of these bottlenecks caused by COVID-19 and its reactionary measures enforced.
- Three, India’s taxation policy on fuel has made things worse. Rising fuel prices percolate into the economy by increasing costs for transport.
- Furthermore, the increase in fuel prices will also lead to a rise in wages demanded as the monthly expense of the general public increases.
- Four, RBI is infusing massive liquidity into the system by following an expansionary monetary policy through the G-SAP, or Government Securities Acquisition Programme.
- Five, an added threat of rising rates is the crowding out of the private sector, which corporates are threatening to do by deleveraging their balance sheets and not investing.
- One, high asset price inflation caused by ultra-loose monetary policy followed across the globe.
The third is interest rates.
- The only solution for any central banker to limit rising inflation is through tightening liquidity and further pushing the cost of money.
- However, rising interest rates lead to a decrease in aggregate demand in a country, which affects the GDP.
- There is less spending by consumers and investments by corporates.
Finally, rising non-performing assets, or NPAs.
- Our small and medium scale sector is facing a Minsky moment.
- The Minsky moment marks the decline of asset prices, causing mass panic and the inability of debtors to pay their interest and principal.
- India has reached its Minsky moment. Several banks and financial institutions have collapsed in the last 18 months in India.
- As a result of the above causes, credit growth is at a multi-year low of 5.6%. Banks do not want to risk any more loans on their books.
- This will further dampen demand for real estate and automobiles once the pent-up demand is over.
The Indian economy is in a vicious cycle of low growth and higher inflation. In the absence of policy interventions, India will continue on the path of a K-shaped recovery where large corporates with low debt will prosper at the cost of small and medium sectors.