A lost year

Indian economy will need careful policy handling

According to the first advance estimates released by the Union Ministry of Statistics and Programme Implementation, real gross domestic product (GDP) in India will contract by 7.7 per cent in 2020-21. This is, of course, primarily a result of the pandemic, which has severely hit economic activity. The sectors most hit during this extraordinary year are those directly affected by social distancing and lockdowns. Trade, transport, and communications are expected to contract by over 20 per cent and both mining and construction would shrink by more than 12 per cent in terms of gross value added at 2011-12 prices. Importantly, from the point of view of livelihoods, the agriculture sector is expected to grow at a healthy 3.4 per cent, which underlies the relative strength of rural demand for many months during the ongoing financial year. To a certain extent, government expenditure was robust, moving from 11.3 per cent of GDP in 2019-20 to 13 per cent in the ongoing year. But capital investment — gross fixed capital formation, or GFCF — reached new lows at 27.6 per cent of GDP. Therefore, although growth will likely appear to rebound sharply for some quarters in the forthcoming year, thanks to a very low base, the fact remains that the main growth engine of the economy, capital investment, continues to run out of steam.

Several analysts have pointed out that, in the second half of the financial year, the recovery has shown strong signs of gathering pace. Such fast-moving indicators as passenger vehicle demand, the collection of goods and services tax, and the purchasing managers’ index, or PMI, have shown solid recoveries. The chances are that India is in the middle of a broad-based reversion to its pre-pandemic growth momentum. Electricity and utilities were up 2.7 per cent over the past year, according to the first advance estimates, which lends some additional strength to expectations of such a recovery.

A 2021 that is dominated by this slow return to normal growth momentum is the best-case scenario. The situation can only be made worse by either a longer overhang from the pandemic than is expected — perhaps due to the spread of new and more infectious strains such as the variant that emerged from South-east England — or by serious policy errors on the part of the monetary and fiscal authorities. The upcoming Union Budget has a major task to perform in this context. It must be recognised that the signs suggest that the economy will be able to return to normal on its own, as long as liquidity and credit remain available. In past crises, the major mistake has been to overstimulate the economy and remain engaged in loose monetary and fiscal policy for too long, in the absence of policy space. This mistake must not be repeated in 2021 by either the finance ministry or by the Reserve Bank of India (RBI). The finance ministry must identify those sectors that most need bridging support over the course of the forthcoming financial year, and ensure that all packages are time-bound and limited in scope. And the RBI will have to clearly communicate its exit from excessively accommodative monetary policy over the course of its next few statements. While, as these estimates show, 2020-21 has been a lost year, the imperative is to ensure this crisis does not leave a long shadow.