A Demand Shock Could Follow the Supply Squeeze of our Lockdown

Livemint     30th September 2020     Save    
QEP Pocket Notes

Context: India saw the sharpest decline in economic output among major economies in the three months to June. It was also one of the very few countries that saw inflation climb in the same period. 

Reason for simultaneous occurrence of decline in growth and high inflation

    • The severity of the lockdown: It disrupted domestic supply chains more than it disrupted consumer spending.
  • Weak labour market: Estimates from the Centre for Monitoring Indian Economy (CMIE) show that the national unemployment rate has fallen from a peak of 23.52% in April to 8.35% in August. 

Economic Concerns: 

  • Stagflation trap: current combination of declining output plus rising inflation will eventually lead India into a stagflation trap.
  • Two-stage economic shock in India: A supply shock, followed by a demand shock.
  •  This is the idea of a paradoxical "Keynesian supply shock", or a situation where an initial supply shock creates a deflationary demand shock in its wake.
  • Risk Aversion: Weak labour market has nudged the households towards caution.
  • Households prefer to keep money in their bank accounts rather than spend it.
  • Aggregate bank deposits have increased by ?6.8 trillion since April 2020, compared to an increase of ?1.5 trillion in the same period of the previous fiscal year. 
  • Financial liabilities of households dropped from 4% of Gross Domestic Product (GDP) in 2018-19 to 2.9% of GDP in 2019-20, the lowest in a decade.
  • Fear of corporate boardrooms: In a survey of chief executive officers (CEOs), 66% of them said they were worried about weak consumer demand.

Issues with labour market: 

  • No clarity on their wages:  It is still not clear whether the millions who have got back their jobs are now working at monthly wages that are at the same level as February, or lower. 
  • Possibility of disguised unemployment:  As people move back to overcrowded farms as a last resort
  • Slower recovery in organized sector jobs: The lack of jobs in the better-paying organized sector has implications on the consumer demand. 
  • Companies had cut wage costs through either salary cuts or layoffs.

Conclusion: A sense of caution in households and corporate boardrooms will weigh down on domestic demand even as the supply side of the economy recovers.

QEP Pocket Notes