Redistributive policy

Policy Settings for 2022 A Tricky Choice -Indranil Pan

India’s growth recorded exceptional growth of 20.1% for Q1FY22 and 8.4% for Q2FY22. Most forecasters predicted real growth of 9.5% or thereabouts for the year, following a contraction of 7.3% the previous year. 2021 has therefore been a period of reconstruction for the economy. India is like a child, seriously injured in an accident and just beginning to recover, although she still needs support. The year 2022 will likely continue to be challenging and political support will be crucial to ensure a soft and safe landing for the economy.

After COVID-19, monetary policy was the first to provide support by easing policy rates and simultaneously ensuring adequate liquidity in the system. Even though the RBI lowered the policy rate to 4%, it lowered the reverse repo rate (widened the LAF corridor) to try to induce banks to lend rather than passively return excess liquidity to the RBI . In addition, it has expanded its balance sheet to ensure that the government’s large borrowing program runs smoothly. RBI has also expanded its role to direct credit flows to the sectors most in need, targeted lending facilities such as TLTROs are examples.

Monetary policy is now at a crossroads, inflation has surprised the world not only by being high, but also proving to be sticky. For India, high and sticky inflation is associated with a large negative output gap, making it difficult for RBI. The RBI shifted towards supporting growth and therefore stayed put with a 4% repo rate and its dovish stance. However, the situation could become tricky if the world (especially the US Fed) launches an aggressive withdrawal of monetary easing, or if Indian inflation shows signs of entrenching.

The RBI has started to move away from the excessively easy monetary policy driven by the coronavirus. It absorbed the liquidity overnight. Its VRRR rate is now close to the repo rate (signalling rate). All other interest rates have started to show upward momentum and we may only be months away from when RBI is expected to raise the repo rate. This means that low interest rate support for the economy would soon be over.

With the tightening of monetary policy, the role of supporting growth falls to fiscal policy. This is contrary to some market expectations that fiscal consolidation would begin in FY23 with the February 1, 2022 budget, adhering to a gross fiscal deficit-to-GDP ratio correction path. The critical nature of fiscal policy is also confirmed by the fact that various segments of the economy continue to face different types of stress. Interest rate tools may not be best suited in this situation.

On the production side, organized and publicly traded companies have weathered the storm better – managing to deleverage, gain market share over smaller entities and are therefore better placed to even pass on input costs higher on consumers. Government policies had been put in place to allow for faster growth of private investment, especially with the PLI scheme, reduction of corporate tax rates, etc. But the reality is that private sector companies have been unwilling to invest in capacity building, even though their balance sheets are lean and balanced and well equipped for the same. The reason: capacity utilization levels are low and hopes of an increase in private consumption demand are lacking.

It’s probably time for consumers to get some help on the tax side, especially as the allure of rock-bottom interest rates is likely to fade. During the COVID-19 crisis, fiscal policy has moved away from any direct transfer of money, fearing that these will be spent unnecessarily. But private final consumption expenditure (PFCE) remains the most crucial contributor to the economy with its share of more than 50% in GDP. The PFCE has yet to recover to pre-COVID-19 levels, although it recorded 9% growth QoQ in Q2FY22. Valuables on the expenditure side of GDP jumped 603% on a quarterly basis in Q2FY22 and also rose 183% from Q2 last year. This represents purchases of expensive durable goods that do not depreciate over time but are not used in consumption or even production. Probably, the savings surplus that was accumulated by the upper strata of society during COVID-19 is now being spent for these purposes and this increase in GDP may not be sustainable.

Rural wage growth is low and negative in real terms. The gap between the employment provided and the work demanded under the rural employment guarantee program is large, which means that the labor force has not yet returned for its urban jobs and that the rural jobs beyond the MNREGA are hard to come by.

All of this forms the basis of the argument that fiscal policy must take over to ensure stable growth, not only in the near future, but also with long-term imperatives in mind. The government must continue to maintain its redistribution policies and stimulate job creation. Inequality exists in access to education and health care, areas the budget should begin to address. Retraining efforts need to be stepped up urgently to absorb labor in new growth areas. This is unlikely to be achieved in just one year, but somewhere a start has to be made. For resources, the government needs to take its asset monetization plans and divestment efforts seriously, strengthen tax compliance alongside some redistributive tax policies.

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