The Cabinet reshuffle on July 7 comes almost at the half-way point of the second term of the Modi govt. The reshuffle has come just in time to change things, both on the ground and in terms of the narrative, ahead of the next set of state elections: Uttar Pradesh in early 2022 and Gujarat in late 2022 are the most important among these. Social and regional considerations aside, here are three things that will shape the economic narrative when the BJP seeks a third consecutive mandate in 2024.

1. Stock market rally can sustain a ‘feel-good’ sentiment among the rich

BSE Sensex, India’s benchmark stock market index, reached yet another all-time high of 53054.76 on July 7. Indian equity markets have been the only silver lining in what are otherwise gloomy, if not grim, economic prospects. However, the exceptional performance of stocks markets is based more on optimism than objective performance. This is borne out by the fact that the P-E multiple — the ratio of stock prices and earnings per share — has been rising steadily.

Surging stock markets have helped sustain India’s image as an investment destination in external markets. The foreign investment which comes is also a source of comfort on the external account front.

Capital gains in stock markets have created a sustained positive wealth effect for Indians who are invested there. Stock markets have provided immunity to a section of the well-off population against the economic downturn which existed even before the pandemic hit. This includes many promoters and entrepreneurs whose wealth is a function of their company’s stock prices.

The market capitalisation of the BSE S&P index has increased by 2.6 times between the quarter ending March 2014 and March 2021. India’s nominal GDP has increased by 1.9 times during this period. However, any significant correction, which might even be justified, given the present valuations, could be a big dampener of economic sentiment. But if stock markets continue to rally till 2024, they might sustain a feel-good narrative among the relatively well-off.

2. …but a fall in already stagnant private sector earnings across classes will hurt

The reason capital gains offer limited political gains is simple. One has to have capital to invest in order to enjoy future capital gains. This skews capital gains benefits towards the already rich. This is why income gains are more important than capital gains when it comes to political goodwill in a country where most people have very little capital.

It is here that the government will face its biggest challenge. The pandemic’s economic shock has inflicted severe damage to labour earnings across the board as the economy sees what is clearly a profit-led recovery. However, even before the pandemic hit, things were not very good.

The Indian economy is characterised by economic dualism, where a large number of people work in subsistence level activities while a small proportion (significant in absolute numbers) is employed in high value activities. In the three decades of economic reforms, most high value activities have shifted to and then grown in the private sector.

A boom in the high value part of the economy also creates tailwinds for its less productive counterpart. India’s IT boom and the real-estate boom driven by a channelisation of salary earnings into the home market is a good example of this virtual coupling. While the IT boom created millions of white collar jobs in the private sector, construction emerged as the biggest source of mass employment outside agriculture.

India’s private sector growth engine suffered a shock after the 2008 global financial crisis as export growth went down. The twin-balance-sheet crisis, which was created out of irrational exuberance on part of firms and lack of prudence and poor governance structures in banks, worsened the problem.

While there were periods of revival during the last phase of the second United Progressive Alliance (UPA) government and early phase of the first Narendra Modi government, the economy never really recovered its pre-2008 momentum. This had a direct impact on labour earnings. Annual growth in total compensation of employees of corporate sector companies as well as daily rural wages stagnated in the second half of the term of the first Modi government.

It can be argued that total compensation of employees for corporate firms does not capture per worker earnings like rural wages. However, the total wage bill of the corporate sector is a good indicator of total income accruing to workers in the organised sector of the economy.

At some point of time, a sense of discontent is bound to set in vis-à-vis the current regime’s inability to usher in a sustained high growth phase. How much of a factor it will be before 2024 will depend more on the extent and speed of recovery from the pandemic’s lows rather than a return to pre-2008 levels.

3. …inflation the most important factor

It is one thing to earn the same amount of money, even a little less when prices are constant. However, well-being levels can fall drastically when incomes are stagnant, and prices are rising fast. Most people in the Indian economy find themselves in this situation.

India’s GDP suffered a contraction of 7.3% in 2020-21. The Consumer Price Index (CPI), India’s benchmark retail inflation measure grew at 6.16% in 2020-21. This is the highest annual growth in CPI since 2013-14, when CPI grew at 9.38%. Inflation was at exceptionally low levels before the 2018-19 elections. Annual growth in CPI was 3.59% and 3.41% in 2017-18 and 2018-19. The current CPI series starts in 2011-12, so inflation comparisons before 2012-13 are not possible.

The low inflation environment is bound to have provided a cushion to slow growth in incomes before the 2019 election. To be sure, it did have an unfavourable terms-of-trade impact on farmers, as the nominal component of agri growth collapsed at a faster pace than non-agricultural growth. The results of the 2018 assembly election results of Madhya Pradesh, Rajasthan and Chhattisgarh were a manifestation of this rural anger. The BJP immediately made a course correction by announcing the PM-KISAN scheme, which offers .6,000 per year to every Indian farmer.

Things are very different at the moment. Even if the headline inflation number comes down — RBI’s Monetary Policy Committee expects it to be 5.1% in 2021-22 – price levels are far too high for comfort. For example, if petrol prices stay at .100 till next year, petrol inflation will be zero, but the prices will still pinch. The return of inflation will also erode the value of welfare entitlements such as cash transfers under PM-KISAN. A farmer in Delhi could have bought 90.7 litres of diesel (.66.14 per litre) from the.6,000 he received under PM-KISAN on March 31, 2019. He would be able to buy only 66.94 litres at the price of.89.62 per litre on July 8, 2021.

What is perhaps an even bigger threat is the possibility of a wage-price spiral. As prices rise, nominal wages will have to increase, especially for those who spend most of their income on essentials. The prices of many such many such commodities are sensitive to international prices such as petroleum products and edible oil. Then, there is always the risk of an adverse supply shock in food items because of freak weather events. India has had an exceptional good run with monsoons during the current government. A drought year could provide an inflationary shock.

Inflation is where the government can be expected to be most proactive in the short-term. India has deregulated petrol-diesel prices long ago. However, they are often regulated when elections are around the corner. This could happen again as the Uttar Pradesh elections come closer. Whether such a price cut will be able to significantly bring down the inflation burden in the run up to 2024 is a difficult question to answer. A sustained rise in inflation also tends to scare investors in stock markets. An effort to curb it by raising interest rates will, in turn, give a negative stimulus to an already growth starved economy. There are no easy choices.


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