Unravelling India’s growth impasse
per cent and private investment by 47 per cent in the second quarter of 2020 relative to the corresponding quarter of the previous year. Associated with that fall, other data indicate, has been a significant fall in employment and incomes, which will trigger further reductions in demand either because of a fall in discretionary spending or a decision to postpone purchases. In the circumstances, private investment will not automatically revive because a quick return to “normal” levels of capacity utilisation is extremely unlikely. Even if the COVID-19 shock were to wane, economic recovery would neither be automatic nor robust.
PERSISTENCE OF PANDEMIC
The reality is that even the probability of a quick fade of the shock is low. In fact, the evidence in India points not just to the likely persistence but even an intensification of the pandemic before its retreat. This may necessitate a return to lockdowns at the regional or local levels, even if not on a national scale. So even the assumption that we are going to be left with only the after-effects of the COVID-19 shock in the fourth quarter of 2020 may be wrong.
The only way the damaging effects of the pandemic could have been partially countered was through strong government intervention in the form of a fiscal stimulus. But, as has been underlined by a number of observers, the stimulus package the Finance Minister announced in March largely involved the repackaging and/or front-loading of expenditure initiatives already announced, and new spending amounted to, at best, around 1 per cent of GDP. Given the intensity of the COVID shock, that was just a fraction of what was needed to counter its effects. In the event, government expenditure rose only by 16 per cent year-on-year in the second quarter, which was nowhere near adequate to neutralise the decline in private consumption and investment. Remarkably, even after the release of the evidence on the massive contraction in GDP in the second quarter, the government seems reluctant to ramp up its fiscal intervention. So, a prolonged crisis seems unavoidable.
This assessment is, of course, based purely on what the pandemic triggered. But before the pandemic struck, the Indian economy, measured even by GDP estimates biased towards inflating growth rates, was slowing dramatically (see chart). From a high of 8.2 per cent in the first quarter of 2018, the rate of GDP growth (year-on-year) had been falling consistently to touch 3.1 per cent in the first quarter of 2020. That slowdown was driven by a recession in demand visible across a wide range of sectors varying from automobiles to biscuits. There was a strong case for a fiscal stimulus to counteract that slowdown as well. Instead, in September 2019, the Finance Minister decided to offer India’s corporate sector a huge direct tax concession. That temporarily boosted net profits but did little to revive private investment since the demand recession had not been addressed. Rather, what the tax cut did was intensify a fiscal crisis that was brewing because of the loss of tax revenues resulting from the growth slowdown. The Finance Minister made a mistake then, as she did after the onset of the pandemic. The result is bound to be a prolonged and severe recession.
It is in this light that the argument that the second quarter contraction had little to do with policy has to be addressed. Policy did play a role, not only because the choice of an altogether sudden and intensive nationwide lockdown was a blunder and yielded little that was positive while devastating the livelihoods and lives of the most vulnerable. The fiscal response to the pandemic was also too tepid to counter its fallout. Policy also did matter because before the pandemic it worsened the fiscal crisis facing the Indian state by attempting to cajole the private sector into playing the role that the state should have taken on. In the event, by the time the pandemic came, given the National Democratic Alli
ance government’s obsession with reporting low fiscal deficit figures and keeping the Central government’s borrowing under control, it saw the means to hike expenditures to counter the economic crisis as limited.
Meanwhile, one other factor has complicated matters on the ground. The consumer price index for July confirmed ground-level perceptions that inflation in India was on the rise. The overall index rose by 6.9 per cent relative to July 2019, which though not alarming in itself was above the 6 per cent ceiling that a conservative Reserve Bank of India (RBI) had set for its inflation target. This was primarily because, despite good monsoons and increased production, the price index for food items rose by 10 per cent. This was a step up from the corresponding figures of 6.2 and 8.7 per cent for June. Clearly, the disruption in supply that the logistical problems the pandemic had created and was creating was taking away some of the benefits that a good monsoon had delivered in terms of agricultural growth. The gross value added (GVA) from agriculture and allied sectors rose by 3.4 per cent in the second quarter of 2020 compared with a 22.8 per cent decline in aggregate GVA across all sectors. Despite this growth, prices were on the rise.
That this was some cause for concern for the RBI became clear when its Monetary Policy Committee decided in its August meeting not to further reduce interest rates to drive recovery and ease the economic pain caused by the COVID-19 pandemic. If in the past a government unthinkingly committed to holding back on a fiscal stimulus looked to the RBI to use monetary measures (however ineffectively) to push for growth, the RBI now seems to be in a mood to hand the baton back to the Finance Ministry. In an interview to Financial Times, the RBI Governor while predicting that the inflation rate would moderate in the coming months also said: “The government will announce more growth-supporting measures.” It is not clear whether that was based on any discussion with the Finance Ministry, though he quickly inserted a note of caution to say: “But whatever fiscal expansion they undertake will be very calibrated and very prudent in its approach.”
In sum, while the COVID-19 pandemic has damaged the economy in India as it has damaged economies elsewhere, the end of a growth episode riding on a credit bubble, the failure to address the resulting recession, and a tepid state response to the Covid-induced economic shock have definitely made matters worse. The result is not just the severity of the current crisis that the second quarter GDP figures underline. That crisis will be prolonged, and expectations of a V-shaped recovery amount to mere wishful thinking. Policy definitely had a role to play in putting the nation in this predicament. m