The article highlights how the faster recovery of the U.S. economy aided by the faster vaccination and stimulus packages may pose a policy challenge to the emerging economies.

About the fiscal stimulus in the U.S.

• With the recent passage of Biden’s $1.9 trillion coronavirus relief package, the cumulative fiscal stimulus amounts to 25 per cent of GDP. 
• This reliance on fiscal stimulus is in sharp contrast to the policy response in the aftermath of the 2008 global financial crisis (GFC) when monetary policy was the main tool.
• The over reliance on fiscal measures is because of the “liquidity trap” — interest rates are already treading close to zero.

So, what does this mean for the US and emerging economies?

• From the US perspective, this is good news.
• The U.S. economy is expected to converge to the pre-pandemic GDP projection after the third quarter of 2021, exceeding it by 1 per cent in the fourth quarter.
• The impact on emerging economies is less certain.
• A booming US economy generally bodes well for global growth as higher demand “spills over” to the rest of the world.
• However, the sectoral contribution to US growth presents a different picture this time.
• Private consumption of goods (tradable) is already back to pre-pandemic levels, while consumption of services remains significantly below pre-pandemic levels.
• As the vaccination drive gathers pace in the US and the economy slowly opens up, it should be fair to assume that the non-tradable sector would be driving growth.
• But given the expected nature of the underlying growth, the positive impact on emerging economies will perhaps be softer.
• With smaller fiscal stimulus in emerging economies and the slower vaccine roll, the US recovery largely being led by the non-tradable sector will result in a divergence in growth between the US and emerging countries.

Policy challenge for emerging economies which is different from GFC

• Post-GFC, a combination of zero interest rates and quantitative easing in advanced economies led to a significant surge in capital inflows to emerging countries in search of higher yield leading to an appreciation of their currencies.
• Now, the situation is exactly the opposite.
• The differential rate of recoveries has already led to capital outflow from emerging economies.
• The rise in yield in the U.S. may further fuel capital outflows in coming days leading to tighter monetary conditions in emerging markets.

What should be India’s policy response

• As far as India is concerned, the macro-economic fundamentals are much stronger than during the taper-tantrum days.
• The foreign exchange reserves remain at historically high levels, the current account situation is comfortable and the inflation rate remains within the target band of the RBI.
• In the event of capital outflows, the RBI should let the currency depreciate as the first line of defence to preserve India’s external competitiveness and intervene only to smoothen out extreme volatility.
• It should avoid the temptation to increase interest rates at the risk of hurting the pace of economic recovery.

Consider the question “Uneven economic recovery on the global level poses a policy challenge to India. In this context, discuss the possible impact of uneven recovery and suggest the policy measures to deal with it.”

Conclusion

Uneven recovery at the global level demands an unconventional policy approach. The policy approach of India should be based on this premise.

Back2Basics: Taper Tantrum

• The phrase, taper tantrum, describes the 2013 surge in U.S. Treasury yields, resulting from the Federal Reserve’s (Fed) announcement of future tapering of its policy of quantitative easing.
• The Fed announced that it would be reducing the pace of its purchases of Treasury bonds, to reduce the amount of money it was feeding into the economy.
• The ensuing rise in bond yields in reaction to the announcement was referred to as a taper tantrum in financial media.

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The article highlights the issues with government expenditure driven by the selling of public sector assets.

How public asset selling could affects private investment decisions

• Public sector assets are not bought by reducing consumption or investment.
• Current investment expenditure depends on decisions taken in the past and is more or less pre-determined.
• Investment decisions that are taken today for fructification tomorrow that may be scaled down by such a purchase.
• However, if investment decisions taken today are scaled-down, then it results in crowding out and such a strategy should be avoided anyway.
• This implies that selling public sector assets therefore does not release any resources from private use for government spending.

How selling public asset has same macroeconomic effect as fiscal deficit

• In case of fiscal deficit, the government puts its bonds in private hands; in sale of a public asset, the government puts its equity held in public sector assets in private hands.
• The macroeconomic consequences of a fiscal deficit on the economy are no different from those of selling public assets.
• However, finance capital, and institutions like the IMF treat the sale of public assets on a different footing from a fiscal deficit, for ideological — not economic — reasons, because they ideologically favour a dismantling of the public sector.

How fiscal deficit leads to wealth inequality

• In a situation of demand-constraints, where unutilised capacity and unemployed workers exist aplenty, if an appropriate monetary policy is pursued, it can have no adverse effects whatsoever, except one: It increases wealth inequality.
• The government expenditure financed by the fiscal deficit creates additional aggregate demand that increases output and incomes until the additional savings generated out of such incomes exactly match the fiscal deficit.
• These additional savings accrue to the savers without their having to reduce their consumption, compared to the initial situation (that is, prior to government expenditure increase).
• Since savings represent additions to wealth, this amounts to putting extra wealth into the hands of the rich.
• Selling public assets puts into private hands public assets, and that too at prices well below the capitalised value of earnings.
• This increases wealth inequality for two reasons:
• First, it does so exactly as a fiscal deficit does.
• Second, the public asset it puts in private hands is under-priced.

Why tax financed government spending should be preferred

• If the same government expenditure is financed by taxation, no matter who was taxed, then there would be no addition to private wealth and hence no increase in wealth inequality.
• Which is why tax-financed government expenditure should always be preferred to fiscal-deficit-financed government expenditure.

What alternative government have

• The obvious one is wealth taxation.
• Taxing away the private wealth created by a fiscal deficit leaves private wealth inequality unchanged at its initial level; it does not exacerbate it.
• If the government is unwilling to impose higher wealth or profit taxes, it can raise GST rates on several luxury goods.

Consider the question “How fiscal deficit financed government spending differs in its impact on weath inequality from the tax-financed government spending?”

Conclusion

Thus, selling public assets to finance government spending is both undesirable and unnecessary.

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The article highlights how Atmanirbhar Bharat policies can play important role in India’s post-pandemic recovery.

Decline of trade-led catch-up growth

• The Asian Development Bank identifies India as an outlier, with the country’s GDP growth likely to range between eight and 10 per cent — as against 7.7 per cent for China and seven per cent for the Asian region.
• The convergence between the rich and poor countries in the 1990s and 2000s was founded on high relative growth rates driven by globalisation and export-led growth.
• The World Bank and many international think tanks are now projecting a process of de-globalisation, reduction in exports, and reduced service exports from the tourism, travel and hospitality sector in response to COVID.
• So, the phenomenon of trade-led catch-up growth is declining.

How Atmanirbhar Bharat is different from past strategies

• India’s import substituting growth strategy of the 1960s did not succeed because the high protective customs barriers led to the growth of non-competitive industries.
• The current Atmanirbhar Bharat project is different because tariffs are low and public investment is focused on non-tradable infrastructure rather than commodity production.

1) Atmanirbhar in heath: Atmirbhar Swasth Bharat

• Atmanirbhar Swasth Bharat is a domestic non-trade dependent initiative which will invest over Rs 64,000 crore in setting up 17,800 rural and 11,000 urban health and wellness centres and 602 critical care hospitals in the country’s districts.
• Today India has 29 health workers per 10,000 population, while we need 60 such professionals per 10,000 people, as per WHO norms.
• Creating such a cadre will mean nearly four million new jobs, which can be self-paying.

2) Infrastructure

• China and emerging markets like Russia and Brazil have a fairly advanced transport and energy infrastructure.
• India has a huge potential to renew its railways and highways and shift to solar energy from its current dependence on coal.
• In fact, the country’s long-neglected fourth largest rail network in the world is undergoing rapid transformation.
• While rail track coverage expanded by 5,000 km during 2010 to 2014-15, nearly 7,000 km of tracks were added between 2015 and 2020.
• The Railways now aim to lay 9.5 km of track daily and have raised adequate capital for the same by leveraging domestic insurance funds.
• Railways are also aiming for 100 per cent electrification and zero carbon footprint by 2024.
• Electrified track has doubled from 20,000 km in 2012/13 to nearly 40,000 km in 2020.
• The Centre’s decision to invest heavily in urban mass transit systems since 2014 has led to the rapid expansion of such services.
• The resolution of financial problems of blocked PPP projects and smooth land acquisition process has increased the pace of construction of national highways.
• Pace of construction of the national highway increased from 3,330 km per year during 2009-20014 to nearly 9,450 km in 2020-21.

3) Renewable energy

• Today over 55 per cent of India’s energy comes from coal but the share of renewable has been steadly increasing.
• Starting with only 10 MW of solar power in 2010, India has installed nearly 35 GW of solar power by 2020.
• This has been propelled by economic reforms which drove solar power prices down from Rs 17 per unit in 2010 to Rs 2.44 per unit in 2020.
• The target of reaching 100 GW by 2022 can drive growth further.
• Currently nearly 25 per cent of India’s electricity is used for pumping underground water for irrigation.
• Providing irrigation energy from decentralised solar grids — solar power can be generated at the points on consumption.
• This will reduce huge transmission losses and the associated carbon footprint of non-renewable energy sources.

4) Privatising public sector outfits

• The Centre’s shift towards privatising public sector outfits including banks, insurance companies and other PSUs can fund the growth of rail, road and energy infrastructure.
• This will also foster efficiency in India’s credit system.
• China achieved supernormal growth in infrastructure without access to international financing in the initial decades.
• Recent studies have revealed that China’s financial decentralisation and commercial exploitation of state-owned lands was critical for the success.
• In India, too, regional development authorities like the Mumbai Metropolitan Regional Development Authority and Maharashtra Industries Development Corporation have financed the metro, trans-harbour links and industrial infrastructure through a similar commercial land allocation model.
• This model can be extended throughout the country to finance infrastructure expansion.

Consider the question “How Atmanirbhar Bharat policies differ from the past import-substituting growth strategy? Examine the role Atmanirbhar Bharat can play in the post-pandemic recovery?” 

Conclusion

In such a way, Atmanirbharta with its various facets will pave the road of post-pandemic recovery.

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The article analyses the success of the inflation targeting mechanism in India and its impact on the growth of the economy.

Background of the inflation targeting policy in India

• It has been three decades since inflation targeting was first adopted in New Zealand and subsequently by 33 other countries.
• India adopted it in 2016.
• The primary goal of inflation targeting was to contain inflation at around 4 per cent, within the allowable range of 2 to 6 per cent.
• The RBI has announced a formal review of the policy instrument now.
• At the first meeting of the RBI Monetary Policy Committee in October 2016, it was also formally announced that the MPC considered a real repo rate of 1.25 per cent as the neutral real policy rate for the Indian economy.
• By a neutral real policy rate, the RBI meant a policy rate consistent with growth at potential (i.e. growth at full employment).

Has inflation targeting worked in India

• The evaluation of IT must provide answers to the following two questions:
• Did inflation decline post the adoption of inflation targeting and what was the role of IT in the decline in inflation?
• Was the adoption of inflation targeting associated with the policy of the highest real repo rates in India — ever — for almost three years 2017-2019?
• The answer is yes to the latter, but it also needs to be acknowledged that high real repo rates were the primary cause of the GDP growth decline in India from 8 per cent to 5 per cent.

Need to take into account the global context of inflation

• An interesting feature of the Indian defence of inflation targeting is that very few take into account the global context of inflation in which the decline in inflation has occurred in India.
• A research paper by Balasubramanian, Bhalla, Bhasin and Loungani at ORF evaluates inflation targeting in a global context and separately for Advanced Economies (AEs) and Emerging Economies (EES).
• Some facts from the paper are the following.
• First, the annual median inflation in AEs has been consistently low, so low that many central banks have official campaigns to raise the inflation rate.
• One conclusion might be that IT succeeded beyond anyone’s dreams in these economies.
• But attributing this decline in inflation to IT would be erroneous.
• Inflation is global and price-taking by millions of producers in the world means that no one producer or one country can influence the price of any item.
• Oil has ceased to be a factor in global inflation, at least post the mid-1980s.
• The lowest inflation in Indian history occurred during 1999-2005, averaged only 3.9 per cent.
• The average median rate among EM targetters during 2000-04 was 4 per cent, and among the non-targeting countries was 3.8 per cent.

Did fiscal deficit play role in inflation targeting

• In 2003, India passed the FRBM act to control fiscal deficits and inflation.
• There is precious little evidence, either domestically or internationally, about fiscal deficits affecting inflation.
• For three consecutive years preceding the FRBM announcement, the consolidated Centre plus state deficits registered 10.9 per cent(in 2001), 10.4 and 10.9 per cent.
• For the seven-year 1999-2005 period, consolidated fiscal deficits averaged 9.4 per cent of GDP.
• Yet, that these years represented the golden period of Indian inflation — without FRBM and without IT.

Cost of inflation targeting in India

• There are also costs to inflation targeting in India.
• It led to higher real policy rates, in the mistaken belief that high policy rates affect the price of food, oil, or anything else.
• But high real rates affect economic growth, by affecting the cost of domestic capital in this ultra-competitive world.
• It is very likely not a coincidence that potential GDP growth, as acknowledged by RBI, was reached just before the MPC took over decision making in September 2016. 
•  Since then there was a steady increase in real policy rates, and a steady decline in GDP growth.

Consider the question “How far has the inflation targeting mechanism been successful in India? Give reasons in support of your argument.” 

Conclusion

So, in the inflation targeting mechanism has not been successful in containing the inflation though there had a cost associated with it which we paid in the form of growth.

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