Opinion | The government’s tight fist has given our economy a body blow

The past decade provides a striking contrast with period 2003-04 to 2010-11, when GDP growth, on average, was 8.4% per annum. However, during the last three years of the United Progressive Alliance 2 regime, 2011-12 to 2013-14, GDP growth slowed down to 5.5% per annum, as the government did little except hope and pray for inflation to slow down and growth to revive. The first three years of the Narendra Modi government, 2014-15 to 2016-17, did witness a recovery, with GDP growth at 7.9% per annum. Yet, it was a story of missed opportunities.

The Modi government failed to address the fundamental problems of declining investment, savings and exports underlying the slowdown. An enormous opportunity created by a sharp drop in world oil prices in 2014, followed by a similar decline in world commodity prices, was entirely lost by the high interest rates that strangled investment and a strong exchange rate that stifled exports. In fact, it was the low oil and commodity prices rather than high interest rates that moderated inflation, while the overvalued rupee only encouraged imports and volatile portfolio investment inflows but reduced the competitiveness of exports.

The slowdown resurfaced when the economy was subjected to two shocks. In November 2016, demonetization dealt a severe blow to output and employment that persisted in the medium-term. The goods and services tax, a good idea, introduced in haste in July 2017, was flawed in conception, with a multiplicity of rates, poor design and complex procedures. The preparation was grossly inadequate in the government for implementation and in the economy for compliance. These two policy decisions surely dampened economic growth during 2017-18 to 2019-20 to an average of 5.8% per annum.

In May 2019, the Modi government was re-elected for a second term with an even more decisive political mandate. Yet, the Union Budgets presented in July 2019 and February 2020, instead of being confident, were diffident, almost timid, because of misguided fiscal conservatism. The reality of the persistent economic slowdown, staring the government in the face, was not recognized, while the political opportunity to revive economic growth by stimulating demand for investment and consumption was lost. In attempting to manage its fiscal deficit, the government simply enlarged the economy’s growth deficit.

The slowdown in 2019-20 was inevitable. The lockdown during its last few days dented it further. But 2020-21 will be far worse, since almost two-thirds of economic activity was completely shut down through April and May. It will be months, not weeks, before production systems and supply chains are restored. In my judgement, GDP growth will be negative, at least -5%, possibly more, in 2020-21. This would be about the same as the worst year in Independent India so far, 1979-80, when GDP growth was -5.2%.

The draconian and prolonged lockdown is a massive shock to an economy already in trouble, and could be the proverbial last straw on the camel’s back. The state of the economy is much like that of a patient in critical condition requiring intensive care. Alas, since the government’s analysis and diagnosis are both wrong, in my view, the prescription cannot be right.

The announced support of ₹20 trillion is an illusory claim. Of this, ₹8 trillion is liquidity through lines of credit provided by the Reserve Bank of India. The effective fiscal stimulus, in terms of extra resources provided by the government, is at the most ₹2 trillion.

This stress on the supply side, while neglecting the demand side, reveals a flaw in analysis and understanding. Even in normal circumstances, the speed of adjustment on the supply side is slow because supply responses take time, whereas the speed of adjustment on the demand side is fast, as incomes spent raise consumption demand without any time lag. At present, if there is little or no increase in demand, supply responses will be slower than usual. Hence, demand must be revived first to kick-start the economy. For the government, its basic aim is to minimize expenditure incurred.

The government’s tight fist is visible everywhere. There is almost no relief for migrants. Cash support for poor households is minimal. Free rations of wheat or rice and pulses, about one-tenth of household needs per month, have been limited to three months, despite massive government stocks of wheat and rice. Micro, small and medium enterprises (MSMEs) have been provided a ₹3 trillion line of credit for loans without collateral, but loans are neither automatic nor assured, while buyers owe MSMEs as much as ₹5 trillion. The limit on market borrowing by state governments has been raised from 3% to 4.5% of gross state domestic product (as suggested in my column last month), but only if they meet specified conditions. Such conditionality, used by the International Monetary Fund in the past, is bizarre. It is not as if the central government is lending to them on concessional terms. States will borrow at market rates.

It is time for the central government to loosen its purse strings. Unless it does so, a recovery and return to normalcy will be impossible. The economy and the people will pay a huge price. But economic and political consequences for the government are also inevitable, and fiscal virtue will provide no alibi.

Deepak Nayyar is emeritus professor of economics, Jawaharlal Nehru University