[Editorial Analysis] Canary in the coalmines

Mains Paper 3: Economy
Prelims level: Fiscal policy
Mains level: Indian economy and issues relating to growth

Context:

• GDP data of last quarter has been released, India and U S A saw much strong recovery than the previous quarter.

RBI forecast:

• Recently the RBI has revised its forecast of growth for the current fiscal year (2020-21) to (-)7.5 per cent compared to its earlier forecast of (-)9.5%.

What is the matter?

• GDP is reported in these ways, like:

• The sectoral, production side; it includes agriculture, manufacturing, services

• The functional, expenditure side; it includes consumption, investment, net exports

• The income side; it includes profits, wages and indirect taxes

• So, we have to understand, which factor of production are propelling the recovery and which are bearing the burden?

• The economic recovery in many parts of the world is too skewed for comfort, driven disproportionately by capital than labour.

• In India, the net profit of listed companies grew 25 per cent in the last quarter. But as well as the revenue is shrinking because firms cut coss which includes employee compensation.

• A sample of about 600 listed firms reveals employee costs (as a per cent of EBITDA) was the lowest in 10 quarters.

• On other hands, if the profit of listed companies is growing 25 per cent, and yet GDP contracted 7.5 per cent, it gives significant pressure on profits of unlisted SMEs, wages and employment.

• This situation is correlated with labour market pressures around the world.

• In U S A unemployed rate remains close to 6 per cent. It is twice to pre covid level.

• In five East Asian economies, employment income has contracted in nominal terms in 2020. Labour market pressures are evident in India too.

• Household demand for MGNREGA remains very high, suggesting labour market loss.

Economy at micro level:

• At that time when economies heal from Covid 19, but the distribution of incomes across capital and labour risks become skewed in favour of capital.

• It may be rational for any one firm to boost profits by cutting employee compensation. But if every firm follows that strategy, that simply skewed future demand and profitability for all firms.

• It explains the quintessential fallacy of composition whom Keynes enumerated.

• Here the Weak demand, in turn, disincentivises re-hiring, reinforcing the risks of settling into a sub-optimal equilibrium.

• As well as the acceleration of technological adoption during covid 19 and differential productivity impacts it is having on capital, skilled and unskilled labour will likely have more impacts on the future capital-labour mix.

• Private consumption was also financed by households running down savings and taking on debt pre-COVID-19.

• So, if job-market pressures induce households into perceiving this shock as a hit on incomes, households will be incentivised to save, not spend in the future.

• This is not true that the immediate recovery will stop. Speed of economy expected to slow as pent-up demand stop, the level of output will progressively reach pre-COVID levels as the economy normalises.

How to get rid of the situation?

• If labour market pressures cutting private consumption, and incomplete global recovery in 2021 cuts export prospects, there will be no imperative for entrepreneurs to invest, especially with manufacturing utilisation levels below 70 per cent heading into COVID-19 outbreak.

• So, Investment will need to be preceded by a durable source of final demand.

• So fiscal policy will need to be supportive for longer than initially envisioned.

• Recognising the uneven nature of the recovery, US policymakers are negotiating yet another fiscal package, and only a small fraction of the large optional boost that the Euro Area and Japan injected will be reversed next year.

• On other hands, developing economies have fewer degrees of policy freedom, they also have fewer safety nets to handle the labour market fall-out. So, freedom is the main aspect for their recovery.

Conditions in India:

• India’s fiscal response has been controlled thus far, with the Centre’s total spending similar to last year and state CAPEX under pressure.

• It’s therefore important for the Centre to step up spending in the remaining months.

• As well as, public investment, and a large infrastructure push, must be the phrase of the next budget. This will be important to boost demand, create jobs, crowd-in private investment and improve the economy’s external competitiveness.

• The main question before us is how will we accommodate this spending.

• As well as if higher infrastructure expenditure is financed by higher asset sales, the heading fiscal deficit can be slowly reduced, even if fiscal impulse remains positive. So it can be the way to undertake fiscal consolidation without fiscal drag.

Conclusion:

• As in the country, inflation continues to remain sticky, the RBI has fever freedom going forward.

• As many meetings were held of the monetary policy committee, now there is a requirement to pass from monetary policy to fiscal policy.This is because the government as a fiscal policymaker have more power than RBI.

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Prelims Questions:

Q.1) With reference to the Northeast monsoon, consider the following statements:
1. About 75 per cent of the country’s annual rainfall is received from the Northeast monsoon between June and September.
2. While La Niña conditions enhance the rainfall associated with the Southwest monsoon, it has a negative impact on rainfall associated with the Northeast monsoon.

Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer: B

Mains Questions:

Q.1) Define the fiscal and monetary policy? What are the steps needed to boosts sectoral reform in Indian economy?

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