Government should Spend More to save the economy

 

As the GDP numbers are out for the Indian economy for the quarter ending June 2020 (Q1), we were staring at a historic low of negative 23.9 percent GDP. This is the first time since independence that India has seen such a sharp contraction in growth, thereby earning the dubious distinction of ‘fastest shrinking major economy’ in the world.

Even though the loss in GDP growth was on expected lines owing to nationwide lockdowns since March, such a sharp contraction is a cause for concern. It now calls for careful planning for corrective action taking into account the options available.

According to the recent National Statistical Organisation (NSO) data both private consumption and investment contracted by 26.7 percent and 16.3 percent respectively.

Private Consumption is the engine of India’s GDP growth which has fallen from 56.23 percent in Q1 of 2018-19 to 54.3 percent in 2020-21. Similarly, investment by private entities, the Gross Fixed Capital Formation (GFCF) has also fallen from 32.0 to 22.3 percent during the same period. The only increase in the components of GDP has been in the expenditure by government and it has risen from 11.8 in 2018-19 to 18.1 percent of GDP  in 2020-21. The increase in government expenditure has been due to increased expenditure in view of the economic relief package of $266 billion announced by the Government in May 2020 as a response to the COVID-19 pandemic.

The package announced by the government was in the form of liquidity support and government guarantee measures. These measures, though necessary did not do much to provide incomes in the hands of people. The widespread lockdowns were a massive blow to the manufacturing, construction, and trade sectors. Construction is also the sector where migrant workers suffered and livelihoods were lost. The hospitality sector was also one of the worst-hit sectors as international travel was banned, domestic travel stopped, hotels and malls closed down for the maximum period of the quarter. The only silver lining has been the farm sector that has shown signs of positive growth and outlook at 3.4 percent. The agriculture sector was predicted to add to India’s GDP this year owing to a normal monsoon though falling demand for poultry hit the animal husbandry sector and no economic activity in the hospitality sector led to a fall in the demand for farm products. Niti Ayog member Ramesh Chand in April 2020 had predicted the farm sector to grow by at least 3 percent and contribute at least 0.5 percent to India’s overall gross GDP.

 

Without an increase in private consumption and investment, the revival of India’s GDP is highly unlikely. Hence, measures to ensure income support, encourage discretionary demand, and pumping of private investment demand seems utmost.

Ironically, the Indian government needs to spend much more at a time when the revenues seem to have dried up. This is required to make up for the lack of private demand to pull out the economy from falling into the vicious cycle of low income- low spending.

Due to low economic activity, the government’s revenue has shrunk. The corporate tax collections have fallen by 23 percent and income tax collections fell 36 percent as compared to the previous years. Also, the Goods and Services Tax (GST) collections fell 12 percent YoY amidst the COVID pandemic. Not surprisingly, the government has already reached 83 percent of the budgeted estimate in the quarter ended in June 2020.

The agency responsible for the implementation of India’s Monetary Policy –Reserve Bank of India (RBI) has already contributed by resorting to conventional as well as unconventional tools of monetary policy like using ‘Operation Twist’ for lowering longer-term yields in a bid to encourage home and auto loans; initiating Long Term Repo Operations (LTRO), raising limits of Ways and Means Advances of states and UTs, etc. Also, the RBI since February last year, not only reduced the repo rate (the rate at which banks borrow from RBI) by a cumulative of 250 basis points from 6.5 percent to 4 percent but also reduced the reverse repo rate of 25 bp, lowering the rate from 4.0% to 3.35% to discourage the banks from parking excess funds with the RBI.

RBI on several occasions has said that it remained committed to ensuring liquidity support in the economy and shall use the Monetary Policy tools (both conventional as well as unconventional) as the need arises. Interestingly, recently RBI has mentioned in a note for measures to contain bond market volatility, “the recent appreciation of the rupee is working toward containing imported inflationary pressures”. This indeed signals that RBI is for using other methods to fight rising prices than just rate cuts.

However, in the current situation, Monetary Policy tools cannot be as effective; as inflation rises, it becomes an additional worry for the Central Bank. Thus, the government has an overarching role to play to revive and boost the economy.

At present, there is widespread uncertainty in the economy and the consumer sentiment is low. The Consumer Confidence in India that had averaged 101.96 points from 2010 to 2020, has recorded a low of 83.70 points in the first quarter of 2020. It reflects a pessimism in the business sentiments and therefore now there is a demand for another fiscal stimulus package from the government. As already mentioned, at this stage the government is not left with many options. The stimulus package is needed to support incomes, businesses, and refinance financial institutions. The worry about exceeding the fiscal deficit target should now take a backseat and the government must ensure that it provides income directly in the hands of people to increase demand as well as create positive sentiment.

The government is now also required to fast track some bold reform measures to support the Aviation industry, Micro Small and Medium-scale industries, tax reforms, setting up a ‘Bad Bank’ for buying stressed assets, etc.

The Indian economy was going through a slowdown before the pandemic struck – but given the fact that there was no direct income scheme in place in absence of economic activity due to lockdown as also the demand and supply constraints have caused a deep impact. Moving forward without financial support from the government would be difficult.