Post-Covid economic recovery: Can the rich also hurt growth?

Although it sounds counter-intuitive, this question is important from a macroeconomic perspective. There are two ways in which this can happen.

Because the rich save more, they bring in the bulk of domestic sources of investment, especially equity and debt. Equity markets in India are extremely overvalued if the current price-to-earnings multiple is any indicator. To be sure, this rally has also been aided by a surge of inflows from advanced countries, where interest rates have plummeted to an all-time low and investors are looking for more attractive options globally. This inflow has led to a surge in India’s foreign exchange reserves. Because these dollar reserves can move at a very short notice, they cannot be invested in long-term productive purposes and must be held in risk-free and highly liquid forms. In an Indian Express column on December 15, Jahangir Aziz, the chief emerging markets economist at JP Morgan, underlined the economic headwinds these reserves have created for India by undermining the fiscal space (https://bit.ly/2M4BwaG).

“Consequently, despite the apparent lack of fiscal space at home, RBI has been funding other countries’ fiscal deficits. Since April this year, RBI has bought $70 billion of foreign assets, presumably mostly US government bonds. That’s roughly 2.7 per cent of GDP. Put differently, while the government has limited its support to the domestic economy, it has, via RBI, invested almost 3 per cent of GDP in foreign assets just in the first half of this fiscal year”, Aziz wrote.

If the Reserve Bank of India were not to hold these reserves in this manner, rupee appreciation could make Indian exports lose their competitiveness. To be sure, imposing controls on movement of such money could get rid of these policy pressures, but it would also mean that stock market rallies like the one we are witnessing currently, and the income growth they bring for the rich, would be far more muted.

Another way in which an income distribution in favour of the rich adversely affects growth is the trade route. The rich, because they consume more sophisticated products, tend to have a higher import-propensity of demand than the poor. All things remaining the same, a shift in income distribution from the poor to the rich, can lead to a rise in imports, bring down net exports and therefore GDP. To be sure, this process has been underway in the Indian economy for a long time now. A 2015 Economic and Political Weekly paper by Zico Dasgupta and Subhanil Chowdhury looked at this question by examining India’s imports (https://bit.ly/2WEuI5w). The paper found that the rise in India’s current account deficit was because of an increase in import-GDP ratio driving up the trade-deficit. The paper disintegrated “the rise in the import–GDP ratio in terms of three main commodities—gems and jewellery, capital goods and petroleum” and found that “the rise in the imports of commodities is a result of the demand pattern in the economy”. “Even with an increase in inequality, the rise in the (GDP) growth rate is seen to be mainly because of higher consumption by the rich. This consumption being mainly driven by import-intensive commodities, there is an increase in imports” the authors noted.

Granted, both the tendencies explained above are not new in the Indian economy. However, if income inequality were to increase further due to the pandemic, which is what the evidence suggests so far, one would expect these headwinds to growth to become stronger.

Important to guard against missing the woods for the tress

This doesn’t mean absolute gloom and doom in the Indian economy going forward. It is entirely likely, as Neelkanth Mishra, the co-head of Asia-Pacific strategy and India equity strategist for Credit Suisse, has pointed out, that the economy will see patches of brilliance in sectors where the rich deploy their accumulated savings to compensate for pent-up or even transformed demand. People opting for bigger houses as work from home becomes a norm could be an example of the latter variety. A Bloomberg Quint story using CIBIL data showing that housing loans are leading the revival in personal loans, supports such anecdotal accounts (https://bit.ly/2M58KGV). However, it is important to keep in mind that it will take some time for the overall macroeconomic picture to emerge clearly. Given the widespread consensus on the damage to the incomes and employment for the non-rich, it would be premature to write-off long-term damage to the economy.

This is the second of a two-part series. The first part (https://bit.ly/3mRPFo7) discussed whether the rich can drive economic growth in post-covid India.