From UPSC perspective, the following things are important :
Prelims level : Not much
Mains level : Paper 3- Understanding the paradox in between booming financial sector and declining economy
Divergence in the financial sector and the overall economy
- India’s major secondary stock market, the Sensex has been found tracking an upward path, from 40,817 on January 8, 2020, to 48,569 a year later, on January 8, 2021.
- The trend indicates that GDP in India has been subdued while the financial sector has continued moving up.
- This paradox has been found to be replicated in other developing as well as advanced economies.
- These include the major emerging economies such as Brazil and Argentina along with advanced economies such as the United States and the United Kingdom.
- It remains an open question whether this paradox can sustain itself.
- If this cannot sustain, it poses risk for those having large exposures in the financial market and also for the economy as a whole.
Let’s understand the financial flows beyond the real economy
- Finance as above, having no counterpart in the productive sector, was identified, first by Karl Marx, as fictitious capital.
- Earnings from fictitious capital include interests, dividends, and capital gains as well as profits on derivatives.
- All the above come in the category of unearned or rentier capital.
- Financial assets, sold with capital gains at higher prices, are met with a rising rather than with the usual declines in demand.
- Evidently, possibilities of accumulating assets turn even brighter with the high-value assets (used as collaterals), fetching credit for further business.
- As for the stock prices, which reflect the stream of dividends over time discounted by interest rates, lower rates can help pitch stock prices higher.
- Cuts in interest rates are often preferred as tools under mainstream prescriptions limiting expansionary policies, which evidently helps stock prices.
- A journey as above for the financial circuit continues, is subject to market confidence.
Role of state
- To look at how finance has attained its present status we need to look at the evolving alliances between finance and the ruling state.
- The path started with the financial deregulation in the late-1990s when banks were allowed to profit by dealing with securities and with the emergence of hedging devices such as futures and options in the market.
- It also reflects the rise of non-bank financial institutions as well as shadow banks operating beyond regulations even at cost for the regular banks which had large exposures to the non-banks.
- The state’s close proximity to big finance is also evident in the revamping of downhill finance, even with bailouts in the name of restoring financial stability.
- It speaks even more of the pro-finance stance of the government in the neglect of upswings in the financial sector despite the continuing downslides in the real economy.
Consider the question “What explains the apparent paradox in the India economy with evident divergence in its booming financial sector and subdued economy. What are the risks involved in such situations? Suggest the measures to deal with such situations.
Catastrophes, that comes with the sudden collapse of confidence in the financial sector, highlight the need for alternative policies on the part of the state as well as a bit of caution on part of individual investors — in a bid to usher in a sustainable and equitable path of growth for the economy as a whole.