After the lockdown: Indian economy's path ahead is riddled with potholes

Since 1950, the Indian economy has contracted only on four occasions — by 1.2% in 1957-58, 3.7% in 1965-66, 0.3% in 1972-73, and by 5.2% in 1979-80
With India entering from June 1 yet another new phase of lockdown, imposed in the wake of the Covid-19 outbreak, there are legitimate questions on what the gradual resumption of economic activities will imply for the country’s economy in the remaining months of the financial year.


The most important of all such questions is about economic growth. Many analysts have forecast that India’s gross domestic product (GDP) is likely to contract, a view that even the Reserve Bank of India has endorsed. Some believe that the economy could see a contraction of over 5 per cent, as others say that the fall in economic output could be even higher — in double digits.


A contraction of the Indian economy of that magnitude would be an unprecedented shock to the system in India after independence. Since 1950, the Indian economy has contracted only on four occasions: by 1.2 per cent in 1957-58, 3.7 per cent in 1965-66, 0.3 per cent in 1972-73 and by 5.2 per cent in 1979-80.


Note that India has not seen a contraction in the last 40 years and if GDP indeed contracts by more than 5 per cent, it would be a new low for the Indian economy. Both these factors would make the challenge of the growth shock in the current year more complex and formidable.


An unprecedented shock


For the current lot of economic policy makers, such contraction would pose a challenge about which they have only read about in economic textbooks or in books on India’s contemporary economic history. Experience counts in handling such grave situations. They will, thus, need the counsel of the few economists who are still around but are now retired and old, having stepped into their late seventies or even eighties. The question is whether the current government will reach out to some of those retired economists and economic policy makers to profit from their expert advice.


The uniqueness of the contraction of the Indian economy this year springs from another factor. When India’s GDP contracted on the four occasions in the past 70 years, the reasons for the output decline were varied, ranging from agricultural distress, food shortage, the aftermath of a war, and even political instability to the slightly delayed impact of an oil shock. The 2020-21 economic contraction would be caused by an entirely new factor: the lockdown of economic activities in the wake of a pandemic outbreak and the disruption caused by the disease across sectors. Managing the aftermath of such a collapse would require special skills.


So far, the government has announced an economic package of about Rs 21 trillion to provide among other things liquidity support to the financial sector, refinancing of small industries and micro-finance institutions, facilitation of collateral-free loans to micro, small and medium enterprises, enhanced cash transfer to farmers and migrant workers, higher financial support for the rural jobs programme, and capital support for social infrastructure initiatives.


However, almost 90 per cent of this package has relied on the resources of the central bank or other public sector organisations including state-owned banks. The actual hit on government’s fiscal capacity is only limited to about 1 per cent of GDP or about Rs 2 trillion. The government has also announced its intention to bring about several other policy changes like allowing the entry of the private sector into more areas of the economy, hitherto dominated or exclusively occupied by public sector enterprises, increasing foreign direct investment in defence manufacture and privatising power distribution companies in Union Territories. These policy changes will not entail any immediate financial outgo from the exchequer, but will have long-term positive consequences for growth.


But the advantages of keeping the fiscal cost of the Rs 21-trillion economic package down to just 1 per cent of GDP should provide flexibility and some latitude to the government in the coming months. As is widely known, the government has already suspended the release of dearness allowance for its 5 million employees and 6.1 million pensioners till July 2021, giving the exchequer a saving of over Rs 37,500 crore in the current year. The increase in the additional excise duty and cess on petrol and diesel will also give the government an additional revenue of Rs 1.4 trillion in 2020-21, assuming those imposts do not have to be rolled back if international crude oil prices inch back to their earlier higher levels. Finally, the government has decided to borrow Rs 4.2 trillion more from the market, raising the total borrowing in the year to Rs 12 trillion.


This means that the government at present has a financial cushion of about Rs 4 trillion. The expenditure saving and additional oil revenue have taken care of almost 89 per cent or about Rs 1.77 trillion of the total fiscal cost of Rs 2 trillion arising out of the economic package. Half of the Rs 4-trillion cushion will have to be used to meet the revenue shortfall that the government will suffer during the year. But this will leave a decent amount of at least 1 per cent of GDP to be used to provide some more direct benefits by way of fiscal incentives or concessions. Expect, therefore, at least another round of a package that could consist of tax cuts or increased financial allocations.


Contraction impact will be uneven


The contraction of the economy will also bring about a significant change in the way Indian businesses operate. This is because the impact of the contraction will not be uniform on all sectors of the economy. There will be many losers as a result of the contraction and the likely increase in the stress for the financial sector will be an additional cause for concern, but there will be some winners as well.


Already, there are indications that sectors such as the fast-moving consumer goods, pharmaceuticals and information-technology service providers have been showing a surge in their capacity utilisation. The automotive sector, on the other hand, will take longer before it can ramp up operations. Other businesses, like those in hospitality and entertainment, may have to re-engineer their business models to overcome the impact of the contraction and the nature of the pandemic.


The nature of the impact will also vary on the location of businesses. Those situated in the containment zones, where the lockdown will expectedly last at least till June-end and may continue even beyond that, will have to face adverse consequences of a shutdown for a longer period. But businesses whose location and supply chains are outside the containment zones will have a relatively promising head start.


There is no denying that India’s foreign trade will be impacted by the decline in GDP. According to analysts, global trade may dip by at least 13 per cent to 15 per cent in the current year. India’s April foreign trade performance bears this out in ample measure. Exports of merchandise goods in the first month of the current financial year crashed by over 60 per cent to just about $10 billion. Imports of goods too fell by 59 per cent to $17 billion. Things are likely to improve in the coming months, but the April performance provides a clue to the nature of the adverse impact the contraction will mean for India’s foreign trade.


What may minimise the adverse impact of poor merchandise exports on India’s external account is its service exports. The decline in that category in April has not been that severe: just 3 per cent down to $18 billion. Imports of services also fell by 6 per cent to $11 billion. Thus, April saw an unusual phenomenon, not witnessed for many years. India’s overall trade (including merchandise and services) in April recorded a marginal surplus of $0.16 billion. If this trend continues, the external account worries will be a little more manageable.


The other reason why the external account may be less stressed by the huge fall in merchandise exports is the trend in international oil prices. A sharp fall in crude oil prices has come as a big relief not just for the government’s finances, but also for India’s overall import bill. Of course, India’s exports (petroleum products are the second biggest export item) will also be impacted, but the pressure on imports will be less.


Jobs, workers and finance


The unemployment rate during the year will remain high, thanks to the lockdown and the consequent decline in GDP output. The Centre for Monitoring the Indian Economy estimates that the unemployment rate has risen to a record level of 24 per cent. Such a high level of unemployment has the potential of causing social unrest with huge economic consequences.


The big question that will have to be tackled during the latter half of the year is how the migrant workers can be wooed back to their earlier places of work. If these workers continue to be at home, the possibilities of India’s agricultural distress worsening cannot be ruled out. Agricultural income from a small and fragmented piece of land will now have to be shared among a larger number of people in the family, unless and until the migrant worker finds that returning to his or her urban workplace is an attractive proposition.


The government will have to play an important role in creating a machinery or framework through which migrant workers and their issues could be looked after and their concerns addressed. Without those migrant workers returning to work, reviving economic output back to the pre-Covid levels will be a difficult task.


An obvious corollary to the Indian economy’s contraction is the worsening of the government finances. Not only will the Centre’s fiscal deficit widen to much higher levels (according to some estimates, this may be over 6 per cent of GDP, against the Budget estimate of 3.5 per cent, thanks to a steep fall in revenues and higher spending), the state governments too will see a spike in their combined deficit to about 4 per cent, compared to the last year’s level of 3 per cent.


Deteriorating fiscal health of the government runs the risk of a downgrade of India’s sovereign rating, limiting not only the government’s but also of Indian companies’ access to foreign capital on reasonable terms. So far, the government has followed a transparent path of financing its deficits and kept its fiscal costs within reasonable limits. But the risks of a downgrade are not completely ruled out yet. 

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