From UPSC perspective, the following things are important :
Prelims level : Relation between inequality and inflation
Mains level : Paper 3- Rising inequality in the economic recovery
As Indian economy recovers from the economic disruption caused by the pandemic, there are dangers of rising inequality and cosequently the rising inflation. The article deals with these issues.
3 features of Indian recovery
- 1) The number of new cases has fallen while the fatality rate continues to drop.
- 2) India has rolled out one of the smallest fiscal support packages globally, with central government spending flat so far this year.
- 3) Inflation is now a big problem, with consumer prices above the 6 per cent tolerance level for the past eight months.
Consequences of low fiscal spending
- It may seem that India is back on the path to recovery.
- But the low level of fiscal spending could leave behind other problems, such as rising inequality.
- Although, in India there was a focus on vulnerable section, there were some misses, such as the urban poor being left out, and the overall outlay was small.
- For instance, demand for the rural employment guarantee programme continues to outstrip supply.
- There is the rise in inequality between large and small firms, which is likely to be felt by individual employees.
- Large firms were helped by cost-cutting, low interest rates, access to buoyant capital markets and increased spending in the formal economy probably helped.
- The smaller listed firms did not do as well.
- Small firms are more labour intensive than large firms.
- If small firms do poorly, it impacts a large number of people.
- All this could impact demand over time.
- Rising inequality could stoke inflation (in services particular).
- Consumption patterns show that the rich in India tend to consume more services than the poor.
- And rising inequality could, therefore, stoke inflation.
Possibility of services inflation
- 1) As a vaccine comes into play, there could be a release of pent-up demand for high-touch services.
- 2) As large firms and their employees do relatively well, they are likely to demand more services, stoking prices.
- 3) Many service providers did not do a regular annual price reset in 2020, so they may raise prices to cover the two years once demand picks up.
- If inflation does become persistent and leads to tighter monetary policy, that could weigh on growth over time.
- To control inflation in 2021, the RBI may have to take steps such as:-
- 1) Gradually drain the excess liquidity in the banking sector,
- 2) Provide a floor for short-term rates, which have fallen below the reverse repo rate.
- 3) Narrow the policy rate corridor by raising the reverse repo rate.
- A quicker exit from loose monetary policy could become another area where India differs from the world.
Consider the question “What are the consequences of economic recovery in the wake of pandemic? Suggest the ways to deal with these consquences.”
Putting all of this together, it seems India will come full circle in 2021. For a while it was worried more about weak growth than high inflation. But as growth recovers, inflationary concerns could reappear.