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Our corona crunch is quite unlike any other crisis in recent times

Lower growth potential, a painfully slow recovery and the risk of hysteresis mean our response can’t go by an old guidebook

India has faced three big economic shocks this century. The first one emanated from the North Atlantic financial crisis at the end of 2008, to end a splendid economic boom. The second one hit when Indian macroeconomic imbalances were exposed after the US Federal Reserve announced in the middle of 2013 that it would gradually end its quantitative easing. We are currently living through the third big shock, as the covid pandemic has brought the entire world to its knees.

A look at key macroeconomic variables as well as policy responses during these three crises is instructive. Let us begin with the initial growth conditions—in the last full fiscal year before each crisis. The Indian economy grew at 9.3% in fiscal year 2007-08, which was the third consecutive year of near-double-digit economic expansion. In the fiscal year ended on 31 March 2013, economic growth was more anaemic, at 5.46%. The recovery from the 2008 shock had dissipated by then. India entered the covid era with weak momentum, thanks to almost eight consecutive quarters of slowing growth. The government estimates that the economy grew an insipid 4.2% in fiscal 2019-20.

The distribution of risks is different when it comes to macroeconomic imbalances. Inflation was climbing before the 2008 crisis. The consumer price index (CPI) for industrial workers grew by 6.2% in August 2008. Inflation based on the new national CPI was 9.63% in June 2013, and 6.58% in February 2020. India had a modest current account deficit of 1.29% of gross domestic product (GDP) in fiscal year 2007-08, thanks to strong export growth. It was a slim 0.9% of GDP in fiscal year 2019-20, though that is better explained by weak domestic aggregate demand, rather than strong exports. On this measure, 2012-13 was the worst, with a massive current account deficit of 4.82% despite a slowing economy.

The terrible combination of slow growth, high inflation and a large current account gap made the rupee especially prone to attack in 2013. It fell from 53.94 to a US dollar in early May 2013 to 66.57 at the end of August. It lost ground in 2008 as well—from 43.79 at the end of August to 49.69 at the end of December. This time around, till now, the rupee has been stable thanks to a balance of payments surplus. The Reserve Bank of India (RBI) spent almost $50 billion to defend the rupee in 2008 and $16 billion in 2013. The central bank has actually added around $54 billion to its dollar reserves since March 2020.

What about the monetary and fiscal policy response? Let us begin with monetary policy. India’s central bank cut its repo rate by a sizeable 425 basis points in the eight months after the 2008 crisis struck. RBI had the space to go in for large rate cuts because of the counter-cyclical monetary policy it had pursued in the quarters before the financial crisis. Interest rates had to be increased by 75 basis points in the aftermath of the 2013 shock as part of a classic defence of the rupee. The cumulative covid-era rate cuts since March have equalled 115 basis points.

As with monetary policy, there was ample space for fiscal action in 2008. The combined fiscal deficit of the Union and state governments was a modest 4% of GDP at the end of fiscal 2007-08, thanks to rising tax revenues on the back of rapid economic growth. The expansionary election budget of February 2008, followed by the policy response to deal with the crisis in the second half of the year, took the combined deficit all the way up to 8.3% of GDP. There was minimal fiscal response in 2013, because the failure to manage a timely withdrawal of the 2008 stimulus had meant that the government had little fiscal space, and the inflation plus balance of payments pressures anyway called for fiscal tightening. This time, India has entered the crisis with a very high fiscal deficit, so how it uses its restricted fiscal space in the coming months deserves to be watched.

What are the lessons from all this? First, India right now has limited policy space to deal with the shock of the pandemic, but comfort on balance of payments should allow the country to take risks. A decline in inflation in the coming months will help as well.

Second, recoveries from the two previous crises were relatively quick, and especially the recovery from the 2008 shock. Yet, there were long-term consequences. India’s potential growth appears to have come down by around two percentage points over the past decade. The recovery from the covid shock will be much slower.

It is likely that India’s economic output will not go back to its pre-covid level till the fourth quarter of fiscal 2021-22. A quick calculation, assuming trend growth of 6%, shows that, over the next two years, India could lose around $350 billion of extra output because of the covid shock. Hysteresis could set in, especially if the country’s capital stock is damaged by firm bankruptcies. The policy response this time will thus have to be very different from the textbook responses of 2008 and 2013.

Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai Academy of Economics

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