IT'S THE ECONOMY, STUPID.
In what should cause discomfort to incumbents the spotlight is now on the covid-19 battered Indian economy and the fallout. EPISODE #37
Dear Reader,
A very Happy Monday to you.
Last week India released its retail inflation numbers for July. Contrary to expectations of some economists the Consumer Price Index (CPI) eased to a three-month low of 5.59%. Welcome relief no doubt, but the last has not been heard on this politically vexing topic of rising prices—especially with both the union and state governments refusing to strain the exchequer by easing taxes on fuel prices. At the same time, despite the jab roll-out gaining momentum and the threat of covid-19 receding to moderate levels, the country’s economy is still taking only baby steps towards normalcy.
Not surprisingly therefore the latest Mood-of-the-Nation Survey by India Today, among other things, flagged the growing concerns about the economy. Accordingly this week I put the spotlight on the economy. Especially since it is an issue that does to an extent influence the choice of voters.
This week’s spectacular picture of Mumbai during the Monsoon is courtesy Rahul Sharma. Rahul has a brilliant eye and has been generous in sharing some of his work for this column. Something which is duly appreciated.
A big shoutout to Rajit, Gautam, Premasundaran, Rahul and Aashish for your informed responses, appreciation and amplification. Gratitude also to all those who responded on Twitter and LinkedIn. It is key to growing this newsletter community. And, many thanks to readers who hit the like button 😊.
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ECONOMIC BLUES
Last week the union government released the retail inflation numbers for July. In welcome relief and contrary to expectations among a clutch of economists the inflation based on the Consumer Price Index (CPI) decelerated to a three-month low of 5.59%. Though it continues to be a cause for worry.
Coincidentally, India Today released its Mood-of-the-Nation survey which highlights the growing concern in the electorate about the economy in general and retail inflation in particular.
Together it reminded me of the winning slogan: “It’s the economy, stupid”. It was coined by James Carville, the strategist for Bill Clinton in his successful presidential bid against George Bush Sr in 1992.
So far no parallel has been drawn as the opposition has been unable to weaponise the economic blues. But this does not mean it couldn’t, especially at the time of the next round of state elections—including the crucial battle for Uttar Pradesh, where the incumbent Bharatiya Janata Party (BJP) is keen on another term. To be sure the state of the economy is only one factor, an important one at that, influencing voter preferences.
The Inflation Challenge
If we go beyond the headline inflation number released last week we will find that the deceleration was brought about by a sharp easing in the increase in prices of food products—it dropped from 5.15% in June to 3.96% in July.
However, fuel inflation continues to be sticky, easing but marginally from 12.68% to 12.38% over the same period. This is largely because the cost of fuel, after the abolishing of the administered price regime, is a pass through to consumers; with both the union and state governments refusing to pare the tax rates (as it is protecting the exchequer from suffering a rout) pump prices continue to rise.
The thumb-rule is that a 10% increase in retail fuel prices causes a bump of 0.5% in inflation. More importantly such a persistently high inflation rate of fuel leaves the overall price level particularly vulnerable to seasonal variations in food prices. And also why overall inflation has remained sticky at such high levels.
A lurking concern is the build-up in liquidity or excess money supply in the system. This is a deliberate strategy to ensure sufficient availability of credit as entities go about repairing and rebuilding the covid-19 battered economy. At the same time though it has created a situation of too much money chasing too few goods—the attendant outcome of which is a potential spiralling in inflation. So far this has not materialised as the demand destruction caused by the covid-19 pandemic and the ensuing lockdown is yet to recover.
Frankly this trade-off between growth and inflation is never easy to address. Especially in the extraordinary circumstances of a pandemic induced economic crisis. If indeed the Reserve Bank of India (RBI), which manages the money supply, was single minded in its pursuit of dampening inflation, as some armchair commentators suggest, then it will have to raise interest rates—putting another squeeze on an economy struggling to stay afloat; something that would tip the economy into a recession.
In short there has to be some out-of-the-box thinking when it comes to policy moves. The RBI governor Shaktikanta Das said as much during his customary press conference after the presentation of the bi-monthly credit policy.
“There are many conflicting objectives which the Reserve Bank has to manage. Any central bank at any point of time is required to manage conflicting requirements that the economy needs and more so in times like this. So, we have to deal with various issues and each issue, the policy action of the Reserve Bank has to be nuanced. It cannot be unidirectional. It cannot be just black and white. It has to be a nuanced policy response. And that is precisely what we have attempted.”
The governor’s deputy, Michael Patra, explained this in even greater detail:
“The approach to inflation is not one of a cold turkey approach, where you slam the economy till it goes limp without inflation; no, that's not the way it is. The flexible targeting framework allows you to secure disinflation over a period of time rather than at a point of time. And that has been our approach. Since inflation has gone to a pandemic high, not demand supply high, but pandemic high of 6 per cent plus, it is important to bring that down not immediately, but over a period of time. And that is what the MPC is striving to do: to set a glide path for inflation that will eventually bring it back to target.”
Unpacking this it is clear that the central bank believes the primary impetus to retail inflation is pandemic induced—largely through supply chain disruptions. After the initial shock this impact is gradually winding down, especially as the economy slowly rebounds. But there is no doubt that the liquidity overhang is creating distortions in the prices of some asset classes. The good news is that the RBI is conscious of this and is keen to avoid a bubble. Its real test will be in its ability to carefully calibrate the unwinding of excess liquidity in the system at some future date.
On the other side of this economic equation is the consumer, who significantly is also the voter. For the last 18 months they have stoically borne the brunt of the economic fallout, especially those associated with the contact economy (like tourism, hospitality and aviation). Mitigation efforts from the union government, including free food grains and cash transfers to 800 million people, has definitely cushioned the blow but not denied the pain.
The National Mood
India Today, the weekly news magazine, regularly publishes its Mood-of-the-Nation survey. It is a good dip stick. The latest reveals that the second wave of covid-19, which originated in Wuhan, China, has all but broken the back of the masses.
Worse they do not believe there is a quick end to their misery. To a pointed question as ‘where they see the economy in the next six months’, the respondents provided an overwhelmingly bleak outlook.
At the time of the last survey in January—before the onset of the second wave—four out of 10 people believed the economic outlook would improve. Seven months later this proportion has halved to 21%. Worse the proportion of those who believe the situation would worsen has all but doubled: rising from 17% in January to 32% in August.
And in what should worry the union government the survey claims that an overwhelming number of people now believe that sufficient steps were not taken to curb inflation. In January this proportion was 35%, compared to 60% in August. This is significant because in politics it is often what you are perceived to be doing rather than what you are actually doing that counts.
Part of the reason for this shift in perception could be the increase in prices of international crude oil being passed on to consumers. Fiscally it is a sound move, unfortunately politically it is not. With constant media focus on even an incremental increase, fuel prices are rapidly emerging as a metaphor for inflation in the currency of voters.
Sooner if not later the government will have to blink. Unless of course international oil prices reverse their trajectory. The problem is that it won’t be enough if the union government pares its tax rates. The states too load their share of taxes—though this is rarely amplified in the media—resulting in a cascading impact on the consumer. The point is that unless the states pitch in and do their bit in sacrificing revenues the impact on the customer may not be significant enough to correct perception.
In the final analysis it is clear that the economy—due to inflation and job losses—is gradually acquiring mind space. And this at a time when a weary nation is approaching the season of cheer: Onam, which was celebrated on Saturday, has launched the festivities. Indeed it is cause for thought for all incumbent regimes, whether it be the union or state government.
Recommended Reading/Viewing
Speaking to reporters after the presentation of the bi-monthly credit policy in the first week of August, the RBI governor Shaktikanta Das shared an interesting nugget of information on the recent history of debt recovery which has not got the media play it deserves. Basically he is talking about the proportion of money banks could recover from corporate loans that went sour.
“If I remember, the total recovery, that is after the hair cut under the Lok Adalat regime, was about 5 per cent. Under DRT framework, it was 6 per cent and I'm referring to the data between 2014-15 to 2019-20, so I am referring to the data during those 5-6 years. In Lok Adalat, the recovery was 5 per cent, while under DRT (Debt Recovery Tribunal), recovery was 6 per cent. Under SARFAESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) framework, the recovery was 20 per cent and under the IBC, it is about 40 per cent. And before the onset of the pandemic, the recovery was 45 per cent.”
I unpacked all this information in a graphic. The message is loud and clear: debt recovery has gained serious momentum under NCLT.
What the governor did not highlight though is that for the first time errant promoters have been put on notice under the NCLT regime. In fact several have already been ousted.
Till we meet again next week. Stay safe.
dear Anil,
The pandemic situation has led to a dismal outlook having cascading impact on GDP, poverty , unemployment and inflation.you are right in your comment as both retail and wholesale inflation is trending up.There is poor credit off take in commercial sector, inadequate spending by govt, slow pace of vaccination and a possible third wave which will have long term adverse effects.
To make the economy more resilient in the future we need systems that can build and retain more human and physical capital during recovery- using policies that reflect and encourage the post pandemic need for new types of jobs, business and governance systems.
The gloom sounds real. A timely alarm bell from Anil. So what is there to look forward to ? For starters the monsoon so far has been good and perhaps maybe the answer to the inflationary pressure. Secondly, the very cause of this predicament, the pandemic, has not yet raised the dreaded head of the third wave. In case India is able to keep any further outbreak under control, then the business sentiment will be optimistic and we could well see a 12% growth in a year's time. With the pent up demand, the hospitality and travel sectors could well be back with a bang. State governments are keen to open up fully and the enthusiasm will be the right booster shot that economy needs. The need to conserve foreign exchange and judicious spending will have to be there. Our domestic demand is enough to propel the economy into a healthy growth trajectory.