Towards real recovery

Policymakers must focus on medium-term growth risks

The economy is expected to contract by 7.7 per cent in the current fiscal year, according to the first advance estimates of national income released last week. Some private sector economists expect the economy to do better than the official projection. This suggests that the economy would break out of contraction in the second half of the fiscal year. While such an outcome would be encouraging, and far better than some of the earlier estimates, the policymakers should not get carried away and ignore the medium-term growth challenges. It is worth remembering that the economy was rapidly losing momentum even before the Covid crisis and the pandemic has added fuel to the fire. There are several reasons why getting back to a higher growth path would be a formidable challenge.

Growth numbers in the next fiscal year must be seen in the context of a contraction in the current year. Higher growth should not be mistaken for a trend. If the actual numbers remain close to the official projections, just regaining the output level of 2019-20 in real terms in FY22 will show a growth rate of over 8 per cent. A slight increase in momentum can take it to double digits, but will not be sustainable. Also, as the economy recovers, policy interventions of the current year will have to be rolled back. The government will be expected to start the fiscal consolidation process to bring down the level of deficit and debt. This could affect the overall demand. Further, the Reserve Bank of India, which has done most of the heavy lifting in terms of providing support to the economy, will need to start unwinding excessive policy accommodation. This will push up the cost of money and affect economic activity in the near term.

Apart from fiscal and monetary policy normalisation, other fundamental factors would also affect growth. Gross fixed capital formation at current prices, for instance, is expected to slip to 24.2 per cent of gross domestic product in the current year, compared to 29 per cent in FY19. Lower levels of investment will be a drag on growth in the coming years. But a revival in investment would be constrained by overall demand in the economy. The crisis has had a significant impact on the labour market. The ongoing economic recovery is clearly being driven by an increase in profitability and efficiency gains — activity is shifting to relatively large firms. This will have implications for employment and demand in the near to medium term. 

The continued high demand for work under the rural employment guarantee scheme suggests that the recovery is not accompanied by a rebound in labour demand. Further, according to the Centre for Monitoring Indian Economy, employment was down by about 15 million in December, compared to the level in 2019-20. This indicates the stress in the labour market. Lower employment will affect overall demand and have a bearing on medium-term growth. Moreover, the protectionist turn in trade policy will hinder exports and pull down potential growth. Thus, as the economy comes back on track in the short run, it will be critical for the government to address the medium-term growth challenges and strengthen recovery.