By Janak Priyani & Raag Haria
The Covid-19 pandemic has brought global economic activity to a virtual halt. While the world was long expecting a recession, the pandemic has surely pulled the trigger. The International Monetary Fund estimates global economy to contract by -3% this year and expects the clout to further deepen should the virus not recede in the latter half of 2020. As for the Indian economy, growth has been decelerating for the past eight quarters, and indications by the Reserve Bank of India (RBI) suggest growth contracting for the first time in four decades this year.
While the recently announced economic package by the government provides much-needed near-term liquidity support and long-pending structural reforms aiming towards medium-to-long-term stability, we must address the elephant in the room—the need to further aid demand recovery. As the economy begins to reopen, we explore the components of aggregate demand and explain why government expenditure is perhaps the only component that can aid growth, going forward.
Keynesian theory suggests, for aggregate demand to increase, at least one of the components of GDP need to expand. Growth in the Indian economy, for long, has been dominated by consumption (PFCE), followed by investments (GFCF), government expenditure (GFCE) and net exports (NEX). However, consumption and investment demand have been subdued for the past few quarters, dragging down overall growth.
These two components were perhaps casualties of a sharp deceleration in credit supply even after an impressive bank clean-up exercise by the government and RBI. The IL&FS debacle in September 2018 only made matters worse. The NBFC sector, which played an important role in fuelling India’s consumption growth, suffered from funding crunches, leading to further squeeze in credit supply and impacting consumption demand. This deceleration is likely to exacerbate, going forward, with estimates suggesting PFCE to grow at its slowest pace in 15 years.
While the government and RBI have taken impressive strides to ensure adequate liquidity in the system, uncertain economic prospects provide little comfort for bankers to lend further. Even though we may see release of some pent-up consumption, industry-wide job/pay-cuts with a growing sense of uncertainty over the future may limit spending to non-discretionary items and force people towards precautionary savings.
A similar cause for worry is the declining rate of investments. Broad-based utilisation levels, as represented by RBI, dropped to 68.6% in Q3FY20, way below the 75% benchmark for new capacity addition, implying suboptimal levels of fresh investments. A higher rate of investments is quintessential for sustainable economic growth. Deteriorating economic scenario and increasing levels of debt with rating downgrades for industries are likely to aggravate existing problems. With utilisation levels at historic lows and significant hurdles in raising new capital, any new capacity addition in the near-future looks highly unlikely.
Thirdly, global trade has been undergoing several disruptions since 2009. Heightened trade tensions between the US and China, with the onset of the pandemic only makes matters worse. Global trade, as monitored by the CPB, witnessed its steepest decline since 2009, falling -4.3% in March over the previous year, with only downside risks from hereon. As for India, our limited share in global trade, along with a battered domestic and global outlook, provide little room for exports to contribute towards growth.
Lastly, government expenditure—the only exogenously determined element in a Keynesian framework. The positive push required to aid demand recovery has to come through the government, seeing as there is limited room for consumption, trade or investments to expand significantly. However, with sparse resources that India has, we must deploy funds that yield a higher return. One key area that can provide the necessary support is through infrastructure investment. A study by S&P Global estimates 1% GDP spend on infrastructure can boost real growth by 2% while creating 1.3 million direct jobs. Historically, countries have used infrastructure to provide countercyclical support to the economy. Some of the most remarkable references are the New Deal in the US, Germany’s expansion post WWII debt reduction (1953) and more recently with China in the wake of the Global Financial Crisis. Reports suggest China sticking to the same strategy this time around, with nearly $600 billion worth of special bonds, again looks towards infrastructure to revive growth.
Notably, infrastructure has strong links to growth, and with both supply- and demand-side features that help generate employment and long-term assets. India already has an upper hand here. Front-loading key projects with greater visibility from the recently announced National Infrastructure Pipeline (NIP) could aid in a quicker growth recovery.
The question then arises: How do we do this? India already has several institutions for infrastructure development purposes, from the likes of IIFCL, IRFC to more recently NIIF. However, over these years, their scale and functioning has remained inadequate. Perhaps a relook with the intention of restructuring these into one large development institution could help reduce inefficiencies and allow for greater leverage. Taking a cue from China, floating special infrastructure bonds through this organisation to accelerate the funding of the NIP could aid a speedier recovery. Furthermore, taking a page from the New Deal and its Reconstruction Finance Corporation, this institution’s ability for greater leverage can be used to make amends to our credit channels as well as development of state government and urban local bodies’ bond markets, providing them with greater autonomy. This could help businesses and bankers overcome risk-aversion and bring back trust in the system, whilst financing new avenues for growth.
At a time when the availability of liquidity is ample and the cost is low, borrowing shouldn’t be so scary. The exogenous component could step-in in a greater way, perhaps because it is the only one that can.
Authors are part of the Economics & Finance team at the NITI Aayog. Views are personal