Reversing the economic reversal
News of a contraction of almost 24% of the gross domestic product (GDP) in the first quarter of this year would have come as a shock to every responsible citizen. The degree of contraction exceeds that in any major world economy. This is not surprising as India combined the world’s most stringent lockdown with the weakest economic stimulus.
For perspective, the actual fiscal impulse has amounted to less than 2% of (2019) GDP while it has been close to 10% in the United States (US). The difference finds its reflection in the relative rates of contraction, with GDP in the US contracting by 9% in the April-June quarter compared to two-and-a-half times that in India. There is no doubt that we are observing something that will have a deep and lasting impact on the economy unless the government responds to this news with decisive and quick action. Above all, a functional economic policy is what is needed now, rather than one that is attractive to the government for reasons either ideological or aesthetic.
That the future of the economy can no longer be ignored is obvious. The lockdown was justified on the grounds that lives are more important than livelihoods. But, life having to be lived without a livelihood is not acceptable five months after the lockdown was first imposed.
Every effort needs to be made to restore economic activity while requiring adherence to wearing masks, social distancing and hand-sanitising. With the magnitude of the contraction now known, the daunting scale of the challenge is evident. The response of policy has to be different from what the government has so far pursued in the name of addressing it.
The nature of the government’s response until now may be seen in the two rounds of announcements made, the first soon after the lockdown was announced in late March, and the other in mid-May. The first was mainly in the form of enhanced rations and the front-loading of payments already announced to farmers under the Pradhan Mantri Kisan Samman scheme, which, as an income-support scheme, would be deemed selective. The second round of announcements by finance minister (FM) Nirmala Sitharaman had two components: A set of guarantees for loans to be made by banks to the micro, small and medium enterprises (MSMEs) and the agricultural sector, and a host of structural reforms. The latter includes private sector entry into defence production and changes to existing laws related to the marketing of agricultural produce.
Totalling the additional public expenditure, the loan amount guaranteed by the Government of India, and liquidity provision announced by the Reserve Bank of India (RBI), the government asserted that it had provided a “stimulus” amounting to 10% of GDP. This was immediately called out as a tall claim, for additional spending announced by the government was estimated at less than 2% of GDP. It is not surprising that the contraction in India has been as severe.
We will have to await the GDP data for the second quarter of the financial year to know whether a recovery has taken place after June. Despite the Centre having lifted the nationwide lockdown, either statewide closures or lockdown in the containment zones, has continued in some parts of the country. However, it would be unwise to expect a V-shaped recovery. Production is undertaken with an eye to demand, and consumption would have fallen with the income loss, as production had been shut down due to the lockdown for most of the first quarter. Firms are likely to wait for inventories to come down to normal levels before restoring production to past peaks.
But the most important reason for believing that a rapid return to normalcy may not be taking place right now is on grounds of the reduction by up to a third in investment as share of GDP, reported by the government along with the most recent GDP figures. Most of this reduction is likely to be of private investment. Private investment will not revive in a hurry given the magnitude of the contraction in output. The present state of the economy is not conducive to investment, nor is the cost of credit down despite RBI’s efforts. The real bank lending rate for fresh loans is higher than it was in March when evaluated in terms of the Wholesale Price Index, which presumably is what matters to investors.
The only lever left is the one the government has revealed itself to be most reluctant to use thus far, and that is public spending tilted towards investment. The pandemic has exposed the parlous state of public health infrastructure in the country. Expansion in public spending could start right there. And, not only because health is constitutionally a state subject but also because state governments are closer to the ground, the Centre could transfer funds to the states for deployment. For this, the Government of India would have to borrow, either from the public or RBI.
At the best of times, economic policy should be functional and not tied down by a dogma that excludes certain options. We are now living in extraordinary times and only extraordinary measures will do.