Beneath the recovery

Context:  Inflationary concerns could begin to dominate as the growth recovers.

Ways in which India stood out during COVID 19 Pandemic

• Success in dealing the pandemic: Broken the link between rising levels of mobility and COVID-19 cases and ensured free movement without the rise in COVID cases. (e.g. successfully celebrated Diwali festival)
• Smallest fiscal support package in the world: Central government spending is flat.
• Hit with Inflation: Consumer prices are above the 6 % tolerance level for the past eight months.

Problems associated with rising Inequality due to low fiscal spending:

• Urban poor was left out: For E.g., demand for the rural employment guarantee programme continues to outstrip supply.
• Rise in Inequality between large and small firms:
  • Large listed firms saw a bigger rise in profits (50 %, year-on-year) while there was acute economic stress for smaller listed firms and unlisted informal firms.
  • Spending moved from small firms to large ones, and smaller firms remain vulnerable to delays or defaults on payments.
• Low demand in future: Due to the poor performance of labour-intensive small and informal firms. E.g. Informal sector employs around 85 % of the labour force.
  • E.g. the sales of more expensive passenger vehicles doing better than motorbike sales.
• Could stoke inflation: Inflationary concerns could reappear in 2021 due to the following reasons.
  • Release of pent-up demand for high-touch services: after vaccine comes into play.
  • More demand for services by large firms and their employees: Consumption patterns show that the rich in India tend to consume more services than the poor.
  • Service providers may reset the prices: which they didn’t do in 2020.

Way forward: for Reserve Bank of India to control inflation.

• Take steps to gradually drain the excess liquidity in the banking sector.
• Provide a floor for short-term rates, which have fallen below the reverse repo rate.
• Narrow the policy rate corridor by raising the reverse repo rate.

Conclusion: India should differ from the rest of the world by quickly exiting from loose monetary policy.