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Photo: Reuters
Photo: Reuters

India’s growth story has never seemed so endangered

The hysteresis effects of our lockdown may be so severe that even big reforms won’t achieve much

We all knew it would be bad, but no one could have predicted just how bad. Then, on 31 August, we learned that India’s gross domestic product (GDP) contracted by almost 24% in the first quarter of the current fiscal year. This means that approximately 8.5 trillion of national income, or about $115 billion at the current exchange rate, has gone up in smoke. India is now the worst performer in the G-20 group of most important economies in the advanced and emerging world, according to data released by the International Monetary Fund (IMF).

Even in advanced economies, which have suffered far smaller GDP losses, the consequences on livelihoods, especially of the poorest and most vulnerable, has been dramatic. In India, with one of the lowest per capita incomes among the G-20, the impact on the poorest households and small businesses has been nothing short of devastating. Of course, there was bound to be an economic contraction when covid-19 hit. Unfortunately, as this column has argued before, the ill-conceived and draconian lockdown—the harshest anywhere in the world in a democratic country—made matters much worse than they needed to be.

As your columnist has also argued previously, the current crisis, even more than the global financial crisis of 2007-9, is likely to have strong and pervasive “hysteresis" effects. That is, even after the virus ceases to pose a grave public health risk, and lockdowns are eliminated, it is going to take a very long time for economic activity to return to normal, if it ever does.

As we now know, the economic slowdown following the self-inflicted wound of demonetization in 2016 carried important elements of hysteresis. Supply and credit links, which had been largely cash-based in the informal sector, among others, remained broken even after high-denomination currency came back into circulation, and some small businesses and poorer households—we will likely never know how many—never recovered to their level of well-being before demonetization.

Likewise, the nationwide lockdown announced by Prime Minister Narendra Modi on 24 March—with a four-hour notice—sparked off a migrant crisis which is not going to disappear overnight, even once things return to normal. One of the key features of economic development is the migration of labour from the countryside to cities. That was thrown into a disorderly reverse gear, with some migrants trapped in cities where there was no longer any work for them, many back home where there had never been any productive work, and many others literally trapped in no-man’s- land, neither here nor there. Like the long-lasting effects of demonetization, the effects of the migrant crisis—which would not have been nearly as bad as it turned out to be had Indians been given enough notice of the impending lockdown—are going to persist for a very long time.

For a government that has otherwise poured money into schemes with considerable largesse, the fiscal response to the crisis was remarkably muted.

According to Fitch Solutions, new spending in the much-vaunted 20 trillion relief package, announced on 12 May by Prime Minister Modi, amounted only to about 1% of GDP, not 10%, as was widely touted, once pre-existing schemes and the effects of monetary expansion were netted out. Fitch reckons that total spending to combat the crisis amounted to less than 2% of GDP.

Even if we count generously and assume that spending on the crisis amounted to 3 or 4% of GDP, this is still significantly lower than in most advanced and emerging economies, which are spending anywhere from 5% to 10% of GDP to mitigate the crisis. Likewise, with a former bureaucrat at the helm of the Reserve Bank of India (RBI), one might have expected the central bank to unleash a bazooka of unconventional monetary policies. Yet, even the central bank’s response has been remarkably tempered.

In normal times, one would applaud this show of both fiscal and monetary rectitude, but a once-in-a-century global crisis, which has caused just about every other country to tear up its rule book of fiscal and monetary policies, does not seem the most opportune time to burnish one’s credentials as a fiscal or monetary hawk.

Nor has the Modi government followed suit with the much-awaited and long-neglected “second generation" structural reforms of land, labour and capital markets, not to mention the allied regulatory reforms that have gone abegging since at least the time of the Manmohan Singh government of 2004-14.

The bad news is that having delayed these much-needed reforms for so long, it may now be too late. Structural, or “supply side" reforms, only work well in eliciting the necessary incentive effects and responses in the context of a healthy economy. No economy in the midst of a major crisis—anything from a war to a public safety emergency, as at present—has succeeded in pushing reforms at a time when people are simply too sick, poor or scared to respond to revised incentives to work, save, invest or innovate.

Just as market incentives function poorly in the absence of the rule of law, they also fail in a time of war or any other kind of emergency. The India growth story may not have merely hit a temporary roadblock, it may be over for the foreseeable future.

I can only hope that I am proved wrong.

Vivek Dehejia is a Mint columnist

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