Economic shocks have hit the informal sector disproportionately due to the small or no financial buffer
Retail inflation levels above 6% have already started to worry the markets, but the Reserve Bank of India is not yet showing any visible concern. So what could be behind the apparent calm of the central bank on this front? Economists believe the rationale is not limited to the obvious arguments to support a burgeoning recovery amid a pandemic that is refusing to go away.
One of the main stopping Governor Shaktikanta Das from driving inflation is the gap between the formal and informal sectors of the economy. “There is no debate that inflation is high. The debate is how big the gap is between demand in the formal and informal sectors. The question is also how much of the demand-driven inflation the formal sector can bring in, “said the chief economist of a foreign bank, asking for anonymity.
Much of the high-frequency economic data represents the formal economy, which predominantly includes large listed manufacturers and service providers. The numerous small businesses and mom and pop shops that make up the informal sector outside of agriculture have been irreparably damaged. Due to the small or no financial buffer, economic shocks hit the informal sector disproportionately.
The weakening of the informal sector poses two major challenges for the RBI. One of these is the employment and income crisis, which can dampen demand. In a detailed report on the informal sector, analysts at HSBC point out that while wages in agriculture have remained stable, wages for non-agricultural employment in rural India have declined. “Unlike agricultural wages, non-agricultural wages in rural India have not been as stable. We note that the two groups’ wages may be different for longer periods of time because they have different drivers, “the report said. HSBC analysts add that this cohort may have been the most borne by Covid. Low wages would In addition, the large formal companies have hit business in the informal sector: large companies have survived the pandemic and have even flourished despite it, as they are eating up the share of small companies.
The second challenge to Das is that much of the inflation has arisen on the supply side. The main driver behind the spike in headline retail inflation is government fuel taxes, and the rest is largely imported inflation due to a sharp rise in global commodity prices. Monetary policy is not effective in containing this price pressure. However, supply-side inflation has the potential to trigger a wage spiral that will consolidate inflationary pressures. When workers expect prices to rise, they tend to negotiate higher wages. The prospects for this are currently limited due to the unequal trading conditions in different sectors alone. The result is that current inflation is reasonably likely to be temporary.
This gives Das the leeway to focus on growth this time as well, as the economy is still weak and the recovery is beginning. “The forward guidance will encourage a continuation of the accommodative policy to protect against growth risks, especially the third wave of Covid. The accompanying comment will take into account inflation risks through close monitoring and refrain from changing the political levers for the time being, “wrote Radhika Rao, an economist at DBS Bank, in a press release.
Meanwhile, the threat of another wave and a moderate pace of vaccination reinforce the central bank’s growth-oriented approach. So the test for the RBI is figuring out how long politics can be extremely accommodating without starting a fire amid inflation expectations.
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