Clutching at Straws

Sushil Khanna & Mritiunjoy Mohanty

Today, the entire country is reeling from an unprecedented economic shock that has destroyed livelihoods and led to widespread destitution. What is more, there seems to be no end to this catastrophic situation which has led to a sharp spike in poverty and hunger which is widespread as never before. Earlier episodes of hunger in India were linked to crop failures and hence were confined to one or two regions or states. Today's destitution is spread across the length and breadth of India. What Is more, though the Covid-19 pandemic has played a role, a bigger factor has been the mis-governance and mismanagement of the economy since 2016. Modi, who inherited an economy that was counted amongst the fasted growing in the world, has brought the country to a situation, where India is seeing the largest contraction in the world. What is more the government is still floundering in its response.

 October 2020 saw the release of two reports: Reserve Bank's (RBI) Monetary Policy Report for the first six months of the fiscal 2020/21, and the IMF's World Economic Outlook report. The prognosis from both these reports was rather grim for the Indian Economy. The RBI acknowledged that the real GDP had declined by an unprecedented 23.9% in the first quarter of current year (2020-21), and forecast that in the full year it would contract by 9.5%. It also forecast, however, that the economy would bounce back in 2021-22 and grow at 10.1%, largely on the back of a low base effect. The IMF forecast a somewhat higher contraction of 10.3% and a lower,8 per cent, growth rate for 2021-22. The RBI's forecast seems to imply that by the end of fiscal 2021-22, the Indian economy would have made good the ground lost due to the COVID-19 disruption. The IMF's forecast, on the other hand, would seem to suggest that by the end of fiscal 2021-22, India's GDP would still be smaller than that in 2019-20. But both forecasts would seem to imply that there will be a V-shaped recovery.

The National Council of Applied Economic Research (NCAER), the only think tank that was in the same ball park in terms of forecasting the first quarter contraction (26% as against the actual of nearly 24%), has forecast GDP growth of minus 12.6% for the full fiscal 2020/21. Most rating agencies have estimates of GDP contraction for full fiscal 2020/21 in the range of 10.8 to 14.8%. Sudipto Mundle of the NCAER suggests that "To achieve a new normal 5-6% trend growth would be quite challenging" let alone 7% as suggested by some analysts (Mint, 16th October 2020). All this to say that despite the RBI's and IMF's forecasts, all we know is that the Indian economy is in a big hole but we do not know how long it will take to come out of its depths.

The IMF also points out that while the Indian economy will see amongst the largest contraction in the world, other developing countries will do better. Brazil will see its GDP contract by only 5.5%, ASEAN countries by only 3.3%, while China will see an expansion of about 2%. In other words, no developing country has been as badly hit by governance of Covid 19 induced lockdown as India. We are seeing the result not of the lockdown, but the callous and unplanned way this was implemented with the costs borne disproportionately by the poor and the vulnerable on whom it was imposed.

The GDP numbers may seem dry to some readers. But a decline in GDP (gross output) also means massive loss of jobs and livelihoods of workers; bulk of whom are employed in the unorganised or informal sectors of the Indian economy. This unprecedented job loss and resulting impoverishment and hunger was witnessed by the entire country with millions trudging towards their rural homes from urban work stations. According to the Centre for Monitoring Indian Economy (CMIE), a whopping 21 million Indians lost their jobs in April 2020, accounting for 25 per cent of those employed (about 80 million). In no country in the world was the lockdown contraction and job losses as severe as in India. This is because of the nature of the lockdown, described by the Oxford University, UK as the most severe in the world. Trucks were abandoned by drivers and helpers on the highways, as roadside eateries, and petrol stations suddenly shut down. Within a few hours of declaration, a curfew was imposed with the police beating and killing dozens of people. Again, no country in the world matched this severity.

India's Finance Minister, Nirmala Sitharaman, claimed Covid-19 to be "an act of God" implying that her government's policy had no role to play in determining the depth of the economic contraction. The IMF's World Economic Outlook (WEO), October 2020, must then have been difficult reading for Sitharaman. The WEO report explicitly argues that the size of the direct fiscal stimulus played a key role in determining the extent of the contraction. Advanced economies which experienced a much smaller contraction averaged a direct fiscal stimulus (where government either spends on projects as in China or puts money in hands of those rendered unemployed as in USA) of 9per cent of GDP. In comparison, India's direct stimulus amounted to a measly 2per cent of GDP. The Finance Minister has stubbornly resisted increasing direct stimuli, choosing the indirect route of pumping liquidity into the system and credit guarantees, with the RBI cutting interest rates and releasing money to banks for lending. In doing this she forgot the most elementary lesson in macroeconomics that when demand collapses, as it did in the first quarter, due to the severe lockdown, supply side measures such as lowering interest rates (by pumping in liquidity) simply do not work. That demand collapses need direct fiscal stimulus to mitigate them. And the cross-country evidence detailed in the IMF's WEO October 2020 is a stunning vindication of that elementary lesson. No, Finance Minister, "Act of God" simply does not wash.

The government has repeatedly said that its room for fiscal manoeuvre is severely constrained because of shortfall in tax revenue mobilisation. On this the government is entirely correct. The RBI in its Monetary Policy Review October 2020 notes that in 2019-20, real GDP at market prices grew at 4.2%, while it grew at 7.5 per cent in nominal terms. Not only was this the slowest growth in nominal GDP since 1978, i.e. in 42 years, but also substantially lower than the 12% that the government had budgeted for. And it is nominal GDP growth that is critical for tax revenue growth. Therefore, despite all the government's rosy prognostications at the time when the NDA-2 started its second term, the Indian economy entered fiscal 2020-21 with a significant tax mobilisation gap, thereby constraining the government somewhat.

Demonetisation & GST
But why was nominal GDP growth so low in 2019-20? Because the economy had been battered by the cumulative disasters of demonetisation and a flawed implementation of GST both of which hammered the economy in terms of demand and supply. Therefore, policy disasters had severely weakened the economy and the subsequent policy choice of a small direct fiscal stimulus simply drove the economy off the cliff. The Finance Minister we understand is still willing to consider a further round of fiscal stimuli. A demand collapse spiralling out control cannot be met by a cautious piecemeal approach. What it needs is a big bang direct stimulus to arrest it so that turning the economy around is a little easier. Otherwise, a lack of demand simply entrenches itself as stubborn expectations.

Which brings to the other point that the IMF WEO Report makes that is germane to this discussion. The IMF WEO October 2020 report also compares cross-country evidence in terms of expected losses on the short term (2019 to 2021) against those in the medium term (2019 to 2025). Again, India emerges as among the worst-affected economies in the medium term as well. So not only is India among the worst affected economies in the short term but also in the medium term. Simply put, the deeper the hole the economy is in, the longer it takes to climb out. And as we have already established and is now generally accepted we are in a very deep hole, and other than some very dodgy assumptions, we really do not know how long it will take us to climb out. It is satutary to note that the USA and Brazil (No1 and No3 in terms of Covid -19 infections, India is No.2) have a much higher direct fiscal stimuli and therefore much lower GDP contraction. No, Finance Minister, the "Act of God" has not determined outcomes.

As it has been noted already, the economy was in very poor shape in fiscal 2019-20 and had been decelerating for 3 years prior, thanks to the stupid demonetisation. The brunt of the deceleration had been borne by investment demand. As the RBI Monetary Policy Review of October 2020 notes, fixed capital formation in 2019-20 contracted 2.8% when the economy grew by 4.2%. And it is investment that has continued to bear the brunt of the economic contraction of 24% in April-June quarter—fixed investment contracted by a whopping 47%! We have good reasons to believe that it has been borne by the unregistered, unorganised, informal enterprises. And it is these enterprises that would have gained the most, and thereby employment as well, from a direct fiscal stimulus. Instead there is reasonable evidence that the indirect stimulus with the RBI's infusion of liquidity and lowering of interest rates has worked disproportionately in favour of large firms rather than small and medium firms for whom it was ostensibly meant.

The government wants the private (corporate) sector to take the lead in reviving the economy. But the private sector is already weighed down by debt-burdened balance sheets and faced with a collapse in demand (and therefore low levels of capacity utilisation) and is unlikely to step in. The RBI Review notes "Private investment may, however, take longer to stabilize, hamstrung by low capacity utilisation, still subdued bank credit and the global recession... The game changer would be public capital spending, given its high multiplier effect." (p.48) The government is happy to let the RBI do the heavy lifting in terms of indirect stimuli, does not seem willing to listen to its advice, clutching instead at straws of a V-shaped recovery.

To conclude, the NDA-II under Mr. Modi has since the 2016 demonetisation taken the economy on a perilous path, destroying jobs and livelihoods and structurally weakening the economy. On top of this, faced with an external Covid-19 shock, the government has proved itself inadept to the task of managing the economy, giving the country a contraction in income that India has not seen in a hundred years. What is more, it seems clueless about how to tackle this sliding economy, waiting for some God to rescue us. Thanks to Mr. Modi and his decisiveness, people will probably see a lost decade in terms of growth and jobs. Amen!

Frontier
Vol. 53, No. 22-25, Nov 29 - Dec 26, 2020