The Outlier State

By the time the gravity of the Covid crisis was appreciated by the Union Government, the Indian economy was already cooling down. Seen on a quarter-by-quarter basis, it was as if a plane had cut off its engines and was gliding down. Then, when the pandemic necessitated stringent lockdowns, the economy went into a tailspin. The first quarter of the new financial year (2020-2021) showed a 24 per cent contraction in output, probably the worst posted by the country in a very long time. Critics of the Government seized on that data and issued a dire prognosis. Some even went as far as to say that it would be three to four years before the economy returned to its pre-Covid growth trajectory.

Those days seem to be fading away. India continued to be in the zone of contraction in the second quarter, but the level of contraction was much smaller than that in the first quarter. At 7.5 per cent, the level of contraction has been dubbed as a ‘rebound’ by many. This has been cheered as a sign of incipient recovery. While there is cause for optimism, it is best to remain guarded. Unlike the forecasts of a ‘total washout’ and India’s grim economic future, the situation stabilised in the second quarter for a number of reasons. The exact causes—festival season demand, ‘pent-up’ demand after the stringent lockdowns, and more—are debatable, but India does seem to be an outlier in some respects.

When the first lockdown was imposed by the Government in late March after Prime Minister Narendra Modi described the situation in a national telecast, it was accepted by Indians at large. Soon enough, critics began carping at the steps. It began as poking fun at some of the steps meant to mobilise the country: ‘clanging and banging’ being a favourite trope to describe an allegedly ineffective Government. By mid-June, when the national lockdowns began to give way to strategies based on regional requirements, a full-blown economic critique was at hand: the lockdown was way too severe and in trying to save lives, the Indian economy had been ‘killed’ in the bargain. But perhaps these lockdowns did have a positive effect. By mid-September, India had ‘bent’ the curve. The seven-day moving average of new confirmed cases peaked by this time. At the same time, there were fears that restoration of mobility would lead to second and later waves in the pandemic. Nothing of that sort happened. In terms of full restoration of mobility and a continuing fall in the number of new cases, India is a complete outlier. In countries like the US where there were no national-level lockdowns but only regional measures, the situation has gone from bad to worse. Much of the world is located in a low mobility, rising cases situation. The reasons why India has managed to restore mobility and has ‘peaked’ will only be known later. But it is safe to say that the early lockdowns helped.

The second feature that distinguishes India from the rest of the world is the rather low spending and fiscal support by its Government. If anything, in the second quarter, government expenditure fell as a percentage of GDP. While India launched a series of support packages that were impressive, the bulk of the support came from the central bank and in the form of credit guarantees instead of actual outgo from the Government’s coffers.

Much of the criticism of the Government by economists, many of whom are conservative in their approach to government spending, rests on the Centre not doing enough to revive the Indian economy. The Government did launch a series of Atmanirbhar Bharat programmes but these packages, as records show, had a rather meagre government spending component. Until October, the Government had sound reasons to be careful as external circumstances (China) and domestic concerns necessitated caution. But things changed after that. Suddenly, GST revenue picked up smartly; household savings witnessed a huge jump and with a current account surplus, the Government, it seemed, had enough resources to spend its way out. It did not. That criticism appears valid, at least on paper.

What remains unanswered while building a case for higher government spending is whether this will impart the necessary momentum to the Indian economy. Careful economists like Jahangir Aziz of JP Morgan have made a case for an extensive income support programme and have convincingly argued that India does have the required resources. But it is quite likely that a one-shot, one-off spending plan will not work and lead to a demand revival. Instead, there is every possibility that this will lead to a hoarding of cash. Aziz calculated that India has lost close to 10 million jobs. This shows that a situation of economic uncertainty exists in India. In such conditions, an income support programme will be effective only if it is extended for a foreseeable future. To borrow game theory terminology, the Government finds itself in what is often called a ‘Centipede Game’. If the income support programme is of a short duration and the recipients know the end date of the programme, they will tend to hoard cash. For the programme to be effective, the Government will have to continue spending for a long time without disclosing what is ‘long’. That is the only way that those enrolled in the programme will have confidence to spend and not hoard cash. This is likely to be an expensive proposition, economically and politically. A rough calculation will show that if the Government decides to support one crore individuals by giving them Rs 1,000 every month for a year, the cost will be Rs 12,000 crore. But that may not be enough to create sufficient, economy-wide demand. Suppose this number is increased to 10 crore people, the cost will gallop to Rs 1.2 lakh crore every year. This may be a sufficiently ‘thick’ layer of people to make a difference to the economy, but it will also blow a hole in the Government’s budget.

Even if one ignores all the constraints, the length of time for which the income support programme has to be carried out, marshalling of financial resources for it and figuring out the design of the programme to make it effective, the real constraints will be political. Once it is launched, it is politically impossible to shut down such programmes: there is always a crisis in any developing country where a case can be made for continuing with such programmes indefinitely. Apart from a permanent drag on the Government’s spending priorities, these programmes also complicate macroeconomic management. There is one possibility, however, under which this kind of spending can become feasible: if the minimum support price (MSP) operations in Punjab and Haryana are rationalised, the Government can always muster the necessary amount of money after diverting what is shelled out for food procurement in these states. If planned carefully with a proper design, this can become the nucleus of a ‘mini’ Universal Basic Income (UBI) programme. If the Government holds its nerve against the rich farmers from Punjab who are trying to hold it to ransom, there is a distinct possibility that in the years ahead, the Government may be able to re-engineer its spending priorities.

The impressive ‘rebound’ in the second quarter economic output data has led to optimism that India may finally be out of the woods by the end of 2020-2021. There is, no doubt, reason for cautious optimism. But the data itself, when viewed differently, offers reasons for worry as well. In a recent opinion piece, Sajjid Chinoy, another JP Morgan economist and a member of the Prime Minister’s Economic Advisory Council (PMEAC), parsed the September quarter output data in terms of profits, wages and indirect taxes. The other two ways are to break down output into private consumption, government expenditure, investment and net exports; and breaking it down into sectoral composition (industry, agriculture, services, etcetera.) It is the latter two methods that seem to give ‘comfort’ as some parts of the economy have picked up from the first quarter doldrums.

What Chinoy showed, however, paints a sombre picture. He noted that net profits of listed companies grew by 25 per cent in the second quarter even as revenue growth of these companies declined. How is this possible? One way for that is when companies slash costs such as wages. This does not bode well for economic growth in the coming quarters. With income uncertainty, reduced wages and job losses, demand is likely to remain muted. There is, of course, a debate among economists about wages and economic growth that is complicated and, at times, assumes an ideological colour. But it is safe to say that in a country like India with limited exports, domestic demand is probably the most important source of growth.

There is, however, a limit to what the Government can do to push private demand. What it can do is push public investment in areas like infrastructure and public works that can serve as a source of work. This is the classic Keynesian remedy to support an economy in trouble. Probably that is what the Government has in mind as it pushes ahead with its spending plans in the months ahead.

GDP growthIndian economymanufacturingNirmala Sitharaman