Opinion | A risk-management approach could guide our next stimulus4 min read . Updated: 27 Jul 2020, 08:49 PM IST
Our worry has shifted from a question of cyclical demand to one of solvency and productive capacity
Since the start of the coronavirus pandemic, the gross domestic product (GDP) projection for India compiled by Consensus Economics in 2020-21 has fallen from 5.9% in February to -4.6% in July. The range of forecasts is wide, stretching from -1.2% to -9.5%, but there is a broad agreement that India’s economy is likely to contract, possibly even in nominal terms. Even the Reserve Bank of India (RBI), which has not updated its economic projections in the past four months, citing lack of adequate data, agrees that the economy will contract.
The economic damage will be felt largely by private households and the corporate sector. The former are likely to experience a loss in income, a definite decline in consumption, and an increase in savings. The corporate sector will not only have a loss of income, but is also likely to see dis-savings, either by running down existing savings or by increasing debt to meet expenses. Both outcomes will be reflected in a loss of India’s private capacity to consume and invest in the future.
When the details of the Atmanirbhar fiscal package were outlined in May, it appeared that the government had chosen to err on the side of caution. Given the constraints it faced, its decision to preserve fiscal ammunition seemed prudent, especially in the light of the uncertainty that subsequently emerged on the national security front.
However, with a once-in-a-generation crisis, the government should periodically update its assessment of whether the recession is going to be deeper than expected, and also the opportunity costs of not acting fast and meaningfully. Reports suggest companies are shelving capital spending plans This is a pity because an RBI report on the investment intentions of India’s corporate sector, gleaned from data on resource mobilization by the corporate sector through various channels and published in its monthly bulletin for February 2020, showed a revival in corporate capital expenditure in 2019-20 over 2018-19. But, in the light of the pandemic, it is not clear how much of the approved funding would actually be invested in projects this fiscal year. Investment would be a big factor in the realization of a V-shaped recovery next financial year.
In the Asian region, South Korea reported a bigger-than-expected export and economic growth contraction in the year’s second quarter. All is not well with the Chinese financial system despite the apparent return of economic growth to positive territory. That is why an orchestrated stock market rally in China could not be sustained. Elsewhere, the massive recovery in stock markets around the world since March, including in India, and in high-yield bond markets have made asset price bubbles far bigger than they were in March, especially in the context of an uncertain outlook for corporate earnings. Consequently, these bubbles pose a significant risk to economic prospects. It is usually the case that stock market recoveries do not have much of a positive wealth effect on the economy, but a crash dampens sentiment and hurts economic activity. All of these make the case for a growth insurance policy through additional stimulus.
In the early days of the covid pandemic, a lot of ink was spilt arguing both in favour of and against the idea of a large fiscal support package to reduce the downside risks to the economy. The argument against a large support package stems from the memory of the 2010-2013 inflation and balance-of-payments crisis, which, it seems, continues to shape the thinking of Indian policy circles. The scars of slow monetary tightening, which eventually gave way to a currency crisis, remain fresh in the minds of policymakers. But, past failure on a policy does not guarantee future failures. The past is a guide but not a prison guard. Context matters.
If it turned out that the government had indeed overstimulated the economy, then the problem of reining in excess demand growth is a relatively easy one to deal with than trying to remove entrenched deflationary tendencies. Learning from the overheating episode of 2012-13, the government and the central bank can move faster to tamp down demand.
The government and RBI have, for the better part of the past 18 months, worked on reviving demand. But, the risk of stagnation also has grown correspondingly, on account of external factors. The nature of India’s economic challenges has shifted from being a question of cyclical demand to one of solvency and productive capacity. Hence, providing large and robust fiscal support to help private consumers and businesses bounce back strongly is also in the government’s interest, especially considering the effects of a negative feedback loop of a deep and/or prolonged economic stagnation on businesses and asset valuations.
It might be prudent for the government to take a risk-management approach to additional stimulus by examining the relative costs and benefits of acting to stimulate versus waiting for natural healing processes to work their way through the economy. Often, patients recover faster knowing that a doctor is in charge and administering medicine, even if it is not a perfect cure.
V. Anantha Nageswaran and Rahul Bajoria are, respectively, a member of the Economic Advisory Council to the Prime Minister and chief India economist at Barclays. These are the authors’ personal views.