To Return To Steady Growth Editorial 25th Sep’20 TimesofIndia

To Return To Steady Growth Editorial 25th Sep’20 TimesofIndia

Economic downturn due to Covid-19:

  • The GDP of India fell by 23.9% in April-June quarter of 2020 relative to that in the same quarter in 2019, according to recent government estimates.
  • The decline is comparable to countries in which economic activity had been similarly severely impacted during the quarter due to Covid-19.
  • For instance, the United Kingdom saw its GDP shrink by 21.7%, Spain by 22.1% and Italy by 17.7%.
  • Less severely impacted Germany saw its GDP decline by 11.7%.

Varied impact across sectors in India:

  • Worst impact:
    • GDP decline in India was concentrated in sectors that bore the brunt of the lockdown.
    • Thus, construction fell by 50.3%; trade, hotels, transport and communication by 47%; and manufacturing by 39.3%.
  • No impact:
    • Agriculture, which had been largely unaffected by the lockdown, could grow at its approximate trend rate of 3.4%.
  • Low impact:
    • Likewise, financial, real estate and professional services, which can be substantially provided online, declined a modest 5.3%.

Demand shock was expected due to lockdowns:

  • The lockdown had administered an unprecedented shock to both demand and supply.
  • The dominant view at the time was that the demand shock would overwhelm the supply shock.
  • This lead to the vast majority of analysts to recommend a large fiscal stimulus (to restore demand in the economy). However, the government chose a modest fiscal stimulus.

However, Supply shocks turned to be dominant:

  • The sectoral pattern of GDP growth during April-June clearly points to the dominance of supply shock.
  • High inflation rates of 7.2% in April, 6.3% in May and 6.1% in June reinforce this conclusion.

Government’s decision on slow stimulus was thus vindicated:

  • As the supply shock dominated the demand shock, the decision by the government to go easy on fiscal stimulus (large stimulus would have been the right decision for demand shock) the is thus vindicated.

What needs to be done now?

  • As the economy gradually returns to its pre-Covid-19 level on its way to 7% plus growth trajectory, both monetary authority (RBI) and fiscal authority (government) need to support it.

What monetary authority (RBI) needs to do:

  • Making credit cheaper and easily available:
    • RBI should tilt towards the side of supporting aggregate demand rather than using its tools to push inflation down.
    • Rising supply of output would help lower inflation in any case.
    • But even if not, it is critical for the central bank not to thwart recovery by making credit more expensive and thus clamping down on investment demand.
  • Prevent rupee from appreciating:
    • It is also critical that RBI prevents rupee from appreciating in response to strong inflows of foreign capital.
    • Increased monetary easing by developed countries in the wake of Covid-19 has led to huge capital flows to emerging markets, especially India.
    • The result has been an appreciation of the rupee.
    • In the coming months, foreign capital inflows are likely to continue at a fast pace and it is critical for RBI not to let them force further appreciation of the rupee.
    • As workers continue to return to work and economic activity picks up, India will need to recapture its share in the world markets for which a competitive exchange rate is critical.

What fiscal authority (government) needs to do:

  • Boost public spending:
    • With regards to fiscal policy, due to Covid-19 related uncertainty, private consumption demand is expected to remain low in the foreseeable future.
    • At this point, any income transfers run the risk of translating into savings rather than extra private consumption.
    • Therefore, the safer bet for fiscal policy is to work its way through a boost to public spending.
  • Spend on infrastructure could give the best results:
    • With regards to public spending to boost recovery, this is a good time for the government to significantly expand its spending on infrastructure.
    • To do this speedily, it will be best to work on cutting red tape and removing bottlenecks facing projects already underway.
    • One major advantage of infrastructure spending is that this is a labour-intensive activity.
    • Therefore, it would create jobs and in turn partially restore the confidence of households as consumers.
    • It may also help catalyse private investment demand in construction related activities.
  • Bank recapitalisation:
    • During 2014-17, India hesitated and delayed recapitalisation of banks on an adequate scale.
      • Consequently, the GDP growth in 2019-20 witnessed its sharpest decline since the global financial crisis.
    • As the economy travels towards normalcy, the country must not repeat this mistake. The government must move decisively to recapitalise the banks pre-emptively.
    • While restructuring of loans will delay bankruptcies, it is a foregone conclusion that when payments on restructured loans become due, defaults will accelerate and the banks’ non-performing assets would grow.
    • If India is to avoid the recurrence of credit collapse it experienced in 2016-17, it must act now.

Increase in expenditure will increase debt:

  • Even before any additional expenditure on infrastructure, fiscal deficit in 2020-21 is predicted to rise to 13% of GDP, which would raise debt-to-GDP ratio to 85%.
  • Increased debt in turn would bring significantly larger interest payments in future years, which will further limit the government’s ability to spend on education, health and defence.

Sale of PSUs and monetisation of public assets can fund the expenditure without increasing debt:

  • A partial way out of this fiscal problem is the sale of public sector enterprises and monetisation of public assets such as roads, bridges, ports, airports and transmission lines.
  • Such a policy will not only get the government much needed revenue but also lead to public enterprises and public assets performing considerably more efficiently in private hands.


GS Paper III: Indian Economy