Why government intervention is needed for Economic recovery?
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Lack of Demand:
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In the case of the Great Depression, demand was created by the Second World War effort.
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In the current scenario, there is no war to create demand.
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Further, the COVID-19 pandemic has resulted in demand destruction as confirmed in the Centre for Monitoring Indian Economy and other surveys.
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To counter demand destruction the western world has spent a lot of money stimulating the economy.
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Rising freight costs, non-availability of containers and a strong rupee relative to major competitors is hampering India’s growth exports to Western countries where demand has been generated.
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Rising Inflation:
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India is suffering from stagnant growth to low growth in the last two quarters along with rise in inflation.
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Causes of Rising Inflation:
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High asset price inflation caused by ultra-loose monetary policy followed across the globe. Foreign portfolio investors have directed a portion of the liquidity towards our markets. Compared to a developed capital market such as that of the U.S., India has a relatively low market capitalisation. It, therefore, cannot absorb the enormous capital inflow without asset prices inflating.
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Supply chain bottlenecks have contributed to the inflation. Essential goods have increased in cost due to scarce supply because of these bottlenecks caused by COVID-19 and its reactionary measures enforced.
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India’s taxation policy on fuel has made things worse. Rising fuel prices percolate into the economy by increasing costs for transport. Furthermore, the increase in fuel prices will also lead to a rise in wages demanded as the monthly expense of the general public increases.
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RBI is infusing massive liquidity into the system by following an expansionary monetary policy through the G-SAP, or Government Securities Acquisition Programme.
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An added threat of rising rates is the crowding out of the private sector, which corporates are threatening to do by deleveraging their balance sheets and not investing.
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Low interest rates:
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The only solution for any central banker to limit rising inflation is through tightening liquidity and further pushing the cost of money.
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However, rising interest rates lead to a decrease in aggregate demand in a country, which affects the GDP.
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There is less spending by consumers and investments by corporates.
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Rising NPAs:
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Our small and medium scale sector is facing a Minsky moment.
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The Minsky moment marks the decline of asset prices, causing mass panic and the inability of debtors to pay their interest and principal.
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India has reached its Minsky moment. Several banks and financial institutions have collapsed in the last 18 months in India.
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As a result of the above causes, credit growth is at a multi-year low of 5.6%. Banks do not want to risk any more loans on their books.
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This will further dampen demand for real estate and automobiles once the pent-up demand is over.
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The Indian economy is in a vicious cycle of low growth and higher inflation. In the absence of policy interventions, India will continue on the path of a K-shaped recovery where large corporates with low debt will prosper at the cost of small and medium sectors.