Timely policy response

Indian policy establishment needs to build capacity

The International Monetary Fund (IMF) on Tuesday reduced India’s growth forecast for the current financial year by 90 basis points (bps) to 6.1 per cent. While the downgrade is substantial, it is not surprising for analysts. The World Bank recently reduced its growth forecast for the Indian economy to 6 per cent. Besides such multilateral institutions, the Reserve Bank of India (RBI) also has cut its growth forecast for the current financial year from 6.9 per cent to 6.1 per cent. The outlook for the Indian economy changed significantly after the official data showed that growth slipped to a six-year low of 5 per cent in the April-June quarter. The downward revision of growth forecast by international institutions is understandable as they normally go by the figures and assessments Indian government agencies offer them. But what is worrying is that the Indian policy establishment has failed to foresee the sharp slowdown. The Economic Survey, presented in July, forecast 7 per cent growth for the current year. The Union Budget went a step ahead with the assumption of 12 per cent nominal growth. Assuming 4 per cent inflation — which itself is an overestimate — it would have required real gross domestic product (GDP) growth of 8 per cent. 

Ideally, the slowdown should have been taken into account in the Budget as the economy has been losing momentum for several quarters. The decline in the April-June quarter was not because of an exogenous shock. True, the global economy has also slowed, but this too was not entirely unanticipated. The biggest disadvantage of not being able to read lead indicators is that it makes the policy totally reactive. Proactive policymaking can help minimise the damage. For instance, in the August review of the monetary policy, the RBI reduced its growth projection for the year by 10 bps, along with a cut in the policy repo rate by 35 bps. It was then reasoned that a 50 bps rate cut would have been excessive. However, it had to scale back the growth projection significantly in the October policy. Since monetary policy works with a lag of about two to three quarters, it needs to be more forward looking. The latest World Economic Outlook of the IMF shows that in the absence of monetary stimulus, growth forecast in the global economy would have been lower by 0.5 percentage point, both in 2019 and 2020. The monetary stimulus has thus offset the negative impact of the US-China trade war to an extent. Put differently, large global central banks evaluated the risks associated with the trade war and took pre-emptive action. Even though the efficacy of monetary policy in advanced economies is being debated, this is a good example of how policymaking should be approached.

Lower growth will also put pressure on the government’s finances. Revenue Secretary Ajay Bhushan Pandey rightly noted in an interview with this newspaper that if the growth projections are lowered, it will affect the collection of goods and services tax. However, if the government had acknowledged the slowdown, it would have been able to account for revenue and expenditure more judiciously. Therefore, it is important for the Indian policy establishment to build capacity to be able to gauge economic activity, which will help shape a better policy response. As this newspaper has argued in the past, the central bank can work on an aggregate indicator based on incoming information to reduce the dependence on official data, which comes with a lag. This will not only help the RBI in conducting monetary policy but also enable the government to make policy adjustments in time.