The Indian economy was battling a crisis even before the Covid-19 pandemic threw it off the rails. Gross domestic product (GDP) growth has been falling for the past three years. From a peak of 8.26% in 2016-17, GDP growth slowed to 4.18% in 2019-20. To make matters worse, there were questions on the veracity of official GDP data – and when Arvind Subramanian, chief economic advisor in the Narendra Modi government’s first term, argued that the numbers were overestimates, the credibility crisis grew much bigger. That the government itself held back the release of a report on employment until the 2019 elections and junked a consumption survey after the findings were leaked to the media further muddied the waters. Then, Covid-19 struck.
Come August 2020, when GDP estimates for the quarter ended June were released, all this took backstage, and for a valid reason. Thanks to a nationwide 68-day hard lockdown that started on March 25, India’s GDP contracted by a massive 24%. There has been a sequential recovery since, with the September contraction easing to 7.5%, but the Reserve Bank of India (RBI) expects the economy to shrink by 7.5% in the current fiscal year. The public discourse has suddenly shifted from high growth to merely growth. RBI’s Monetary Policy Committee’s projections of the economy growing at 0.1% and 0.7% in the quarters ending December 2020 and March 2021 have been received with enthusiasm.
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That the Indian economy is making a sequential recovery (month-on-month) is beyond doubt. Measures such as the Nomura India Business Resumption Index (NIBRI) suggest that economic activity is already very close to pre-pandemic levels. However, that is not the central question anymore. Come June 2021, the base effect will give an artificial boost to growth numbers for at least four quarters. For instance, even if the June 2021 GDP growth rate is 20%, it would mean that in absolute terms the GDP would still be lower than what it was in the quarter ending June 2019.
The real economic challenge for India lies beyond 2021-22. Once the favourable base effect has subsided, what will India’s growth trajectory be? It is this question that has polarised economists.
One school of thought – the government subscribes to this – is that the pandemic’s shock has unleashed what the Austrian-born Harvard economist Joseph Schumpeter described as the process of creative destruction. Inefficient businesses and policies, which were holding back the India growth story, have perished with the pandemic and what awaits us is a radical realignment of productive resources which will unleash hitherto untapped tailwinds for growth. This would not have been possible had the government not unleashed second generation reforms in critical areas such as agriculture and labour, which its predecessors shied away from implementing, not because of ideological differences but lack of political will and mandate. More could happen on this front, especially on disinvestment and perhaps corporate houses being allowed to run banks once again. There are credible and respected economists who subscribe to this.
The other school of thought – and this too has credible economists subscribing to it — believes that the pandemic’s shock will only exacerbate the crisis the economy found itself in earlier. The pre-pandemic economic slowdown was not a result of lack of second-generation reforms, but a lack of demand, they argue. India’s rich, while they are a significant number in absolute terms, are not enough to drive the country’s macro growth story. They might also have increased their precautionary savings in the wake of the pandemic. It is the poor, who spend a much larger part of what they earn, sometimes even more, who matter for mass demand and hence growth. It is this large underclass, whose incomes took a hit from policies such as demonetisation and the Goods and Services Tax, which has also suffered disproportionately during the pandemic. While the policy response offered them subsistence-level support through increased allocations on the rural employment guarantee scheme and free rations, it has not done much to provide what economists refer to as a fiscal counter-cyclical boost. On the contrary, the reforms, which are being held up as revolutionary, might trigger a fresh income squeeze on this underclass. In the name of getting rid of local middlemen, farmers may be exposed to corporate buyers with much larger bargaining power than earlier. The labour reforms might have done away with even basic protections at workplace. The current recovery is more likely to be profit-led than wage-led, economists are telling us. This also means that it has a much smaller base. The pandemic’s headwinds to mass demand could generate a vicious cycle and stall growth.
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Both arguments have their merits – and their proponents. It is unlikely that the debate will be settled anytime soon. And interestingly, there are enough data points to support both arguments. If high-frequency indicators support one, consumer confidence surveys, support the other. And we will not have anytime soon, the comprehensive employment and consumption spending data (the best proxy for income data in India) that is indispensible for this debate to be settled this way or the other.
This is exactly why the state of politics needs to be tracked as closely as the economy. In Narendra Modi, the Bharatiya Janata Party (BJP) has a leader whose popular appeal is unmatched by any Indian politician in decades. While there is a clear ideological, Hindutva component to Modi’s popularity, it is also based on a simultaneous process of delivering centralised welfare benefits to a large number of poor people. The ability to keep delivering on this front depends on budgetary resources, themselves a function of overall economic growth. While moves such as demonetisation and the implementation of GST in Modi’s first term were portrayed as a surgical strike against the corrupt, current second generation reforms are being sold as changes which will boost the income (not asset holdings such as toilets, or houses or cooking gas cylinders) of the poor. Which is why the only thing that can be said with certainty at this point of time is that the jury assessing the economy’s performance is likely to move beyond economists and expand to include the people at large.
Limited capacity to absorb Covid-19 shock due to downturn
The Indian economy was in an acute downturn even before the Covid-19 pandemic hit the country. Gross Domestic Product (GDP) growth fell from 8.3% in 2016-17 to just 4.2% in 2019-20. The slowdown came against the backdrop of two big policy disruptions to the economy: demonetisation in November 2016 and the roll-out of Goods and Services Tax in July 2017. Because both government revenue and corporate health took a hit from the prolonged slowdown, the capacity of the Indian economy to absorb the Covid-19 shock was already limited.
Among major economies globally, one of the worst hit
India has been among the worst hit by the economic impact of Covid-19. According to the IMF’s World Economic Outlook published in October, India’s GDP is expected to contract by 10.3% this year. This is a much higher contraction than that expected for most major economies of the world. While economic growth is expected to increase sharply to 8.8% in the next fiscal year, this is more a reflection of the base effect and the 2021-22 GDP is likely to be lower than the 2019-20 level. To be sure, many other institutional and private forecasters have projected a lower contraction . For example, the Reserve Bank of India has projected a 7.5% contraction in India’s GDP this year. Even if the RBI’s projection turns out to be correct, the fact remains that India will be among the worst performing major economies this year.
Fiscal stimulus not enough of a response
India imposed one of the most stringent lockdowns among all countries in the world on March 25. For the next 68 days, when the maximum restrictions were in place, economic activity took a huge hit. It was primarily the lockdown that led to a collapse in GDP in the June quarter this year, causing growth to contract by a record 23.9%. Once the restrictions were eased, a sequential economic recovery has been gaining momentum. Most high frequency indicators, be it the Nomura India Business Resumption Index or Purchasing Managers’ Indices, capture this trend clearly. While most economists agree that India has done well to deal with the supply-side impact of the pandemic, the jury is still out on whether or not this sequential recovery will face demand-side headwinds.
Economic recovery gaining momentum
While India imposed one of the harshest lockdowns to deal with the spread of the virus, the economic policy response to the pandemic, at least the fiscal part of it, has been among the weakest in the world. A very large part of the economic policy response to Covid-19 has focused on credit guarantees and liquidity measures, even as calls for fiscal intervention to spur demand and income growth became louder. While the government did announce some key pro-poor measures such as increasing allocation on the rural employment guarantee programme and providing free rations, their overall fiscal impact was limited.