A cycle of low growth, higher inflation

Context: Unless policy action ensures higher demand and growth, India will continue on the path of a K-shaped recovery.

Background: Recently, right­leaning economists have been arguing that the Government does not need to do anything with the economy and that it will revive itself. This is like after the Great Depression, the economy rebounded worldwide, and so will it with us.

Challenges before the self-recovery of the economy: As argued by the Right-economists.

• Demand remains weak: In post-Great Depression 1929 scenario, demand was created by the Second World War effort. No such situation is present currently due to - 

• Income loss: Centre for Monitoring Indian Economy and other surveys confirms many jobs have been lost, and even where jobs were retained, there have been pay cuts.
• Structural issues: From the point of view of Indian exporters, rising freight costs and non-availability of containers meant they are not in a position to capitalise on rising demand.
• Dangerous cycle of high inflation and depleting growth: 
• Negligible absolute growth: Any statistical growth in the last two quarters is on account of low base effect.
• Causes of inflation: Imported through a combination of high commodity prices and high asset price inflation caused by ultra-loose monetary policy followed across the globe.
• Asset price inflation: As India has low market capitalisation (compared to US), it cannot absorb enormous capital inflow without asset prices inflating.
• Furthering inequality: India’s wealthy upper class gets richer due to access to financial assets while wealth of middle and lower-middle class gets eroded due to high indirect taxes and high inflation.
• Supply chain bottlenecks: Essential goods have increased in cost due to scarce supply because of these bottlenecks caused by COVID-19 and its reactionary measures enforced.
• Rising fuel prices: India’s usurious taxation policy on fuel percolates into economy by increasing costs for transport and rise in wages demanded as the monthly expense of the general public increases.
• Limitations of monetary policy: Claiming this inflation is transitory in nature, RBI has chosen to persist with expansionary monetary policy (in order to keep the interest rates of government bonds at 6.0%). 
• This overlooks the threat of crowding out of the private sector (due to rising interest rates, corporates prefer to deleverage their balance sheets and avoid investments)
• Tightening liquidity or hiking repo rates comes at the cost of a decrease in aggregate demand.
• Rising Non-Performing Assets (NPAs): Rising interest rates, lack of liquidity, and offering credit to leveraged companies instead of direct subsidies to MSMEs will result in higher NPAs.
• Minsky moment of MSME sector: Marked by decline of asset prices, causing mass panic and the inability of debtors to pay their interest and principal.
• Credit growth at a multi-year low of 5.6%: As NPAs rises, banks need capital in copious amounts to make up for bad debt, but Union government’s Budget is in no position to infuse.