India’s GDP is estimated to have increased 7.2 per cent in 2017-18 and 7 per cent in 2018-19. Its performance has been quite stable in last 6-7 years after recovery from impact of global financial recession.
- Similarly, the Indian economy has witnessed a gradual transition from a period of high and variable inflation to a more stable and low level of inflation in the past five years, according to the Economic Survey.
- The current phase of low inflation is also marked by a reduction in both urban and rural inflation.
- Based on this the survey argued that amidst the gloomy landscape of unusual volatility in the international economic environment, India stands as a haven of stability and an outpost of opportunity.
It also introduced a concept of Rational Investor Ratings Index.
RIRI combined two elements:
(i) growth, which crucially determines rewards and returns
(ii) macroeconomic stability (which proxies for risks).
The Macro-Economic Vulnerability index includes a country’s fiscal deficit, current account deficit, and inflation.
Importance of Macroeconomic stability
Investors like macroeconomic stability. If the economy is not well-managed, financial markets react negatively, at times even disproportionately, making economic management a lot more difficult, which can lead to a full-blown crisis. In 2013, India was struggling with high inflation and high current account deficit. However, since then, fundamentals have improved a great deal and macroeconomic indicators now look less vulnerable. Inflation has come down, the current account deficit is under control, and the government has committed itself to a lower fiscal deficit target. For economic activity to grow at a healthy pace, it is important that the economy is managed well.
Differently put, for economic activity to prosper, among other things, it is important that inflation is low, government finances are handled well, imbalances are avoided on the external front, and the financial system is stable. Economic activity is likely to suffer if the economy is vulnerable to internal or external shocks. Therefore, it is important for policymakers to be watchful and take necessary steps, in time, to avoid extreme consequences.
Details of inflation management
Former RBI Governor Raghuram Rajan has pointed out, inflation robs the earnings of the poor and just about anyone with a fixed income. “Inflation is the silent killer because it eats into pensioners’ principal, even while they are deluded by high nominal interest rates into thinking they are getting an adequate return”.
On one hand, Inflation targeting has, in part, helped keep inflation in check. India formally adopted an inflation target in March 2015. This came after a committee headed by now governor Urjit Patel recommended that retail inflation be made the nominal anchor for monetary policy. After discussions between the government and the RBI, a flexible inflation target of 4 (+/- 2) percent was set.
How Steady growth rate and low inflation has been good for a country?
- Low inflation has helped to promote stability, confidence, security and therefore encourages investment.
- High inflation robs the earnings of the poor. Low inflation increased disposable income and therefore increases demand and investment in the economy.
- Low inflation and High GDP growth made Indian exports more competitive.
- Low inflation helped in keeping interest rates in check, which in turn helped the corporate sector.
- Steady growth rate made possible for the government to introduce reforms such as GST.
- Steady growth also provided for better revenue prospects which assisted the government to increase the contribution in various social sector schemes for example 17 per cent hike in allocation to Women and Child Development Ministry.
How steady GDP growth and low inflation were not sufficient:
- Low inflation means a high real interest rate that, in turn, tends to crimp investment activity.
- When companies see profits decline, they tend to scale back expenses by firing some workers or, leads to an increase in the unemployment rate.
- Tax collections depend on nominal GDP growth — lower the latter, the higher the chance of missing tax collection targets forcing GoI to slash expenditures to meet fiscal targets.
- Low inflation signalling economic problems because it is associated with weakness in the economy in the future.
- High Economic growth has not resulted in employment generation. Higher the unemployment lowers the demand or consumer confidence which further impact investment.
As both investments and consumption slow, economic growth suffers. This causes revenues to decline even more, and the economy is pushed into a negative spiral. Tax revenues fall. There are more bad loans. It strains bank balance-sheets even more. India has experienced all of these symptoms since the late-2014, when inflation hit 4% level.
- Low inflation has resulted in reduced returns for farmers. This has adversely affected the rural economy and resulted in agrarian distress.
- In the extreme, when an economy’s inflation rate turns negative, it raises additional concerns and the prospect that the economy slips into deflation.
- There can be a conflict between economic growth and inflation. In periods of rapid economic growth, inflation is likely to rise.
- However, it is possible to have both low inflation and positive economic growth – so long as the growth is sustainable and productive capacity increases at a similar rate to aggregate demand.
Role of increasing GDP and low inflation in maintaining healthy economy
Creation of assets
As the GDP grows, there is steady flow of external investments in form of FDI and FII, which help in providing the required impetus for the growth. Similarly when inflation is down, people are left with more money in their hands after spending on necessities. The left out money is used for creating assets in form of real estate, gold or automotives. All these factors together help in economic growth.
Increase in public and private expenditure
As more money arrives in the economy, more is spent in form of short term and long term gains. Lowering of inflation will enable general public to spend their incomes, which will boost demand for goods and services. This keeps the cycle of economy running.
Increasing income of public and reduced expenditure
As growth keeps on occuring steadily public income gets increased. Over a period of time this extra income accumulates, leading to more chances for spending. Similarly, due to low inflation, people do not have to worry about meeting their mandatory expenditure. Their percentage of growth in income will be far ahead than increasing rate of inflation.
Thus, we can infer that GDP growth and reducing inflation created fertile ground for boosting domestic economy that made India one of the fastest growing economies of the world.
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