Despite the uncertainties from Omicron and unanticipated normalisation of monetary policy in advanced economies, there is optimism that India’s economy will brush past these difficulties. Some have anchored this confidence to project a robust growth path in the medium-term, underlining no significant damage to potential growth by Covid-19 and fair insulation from possible tapering. Such expectant projections seem presumptuous, especially when Covid has induced much forecast errors. Economies over the world have been engulfed with bouts of optimism followed by sense of losing momentum as policy makers struggled to understand distorted demand patterns, the various constraints in supply-chain response, and other such. India could be no different—the current recovery phase could be slanted by bunching of pent-up demand that could fizzle out.
Leaving aside the possible scarring from Covid, the pre-Covid economic health itself raised doubts if this optimism was justified. If the drivers of pre-pandemic weakness were structural, the risks of sharp shrinkage in potential growth are high; return to a higher growth path could then be herculean. Therefore, a fair assessment of pre-Covid trend growth is critical to impart credibility to aspirations of higher medium-term growth. Unfortunately, Covid’s arrival from March 2020 diverted attention from a rigorous analysis of why growth collapsed in FY20?
To recapitulate, 2019 had begun with a notch of growth optimism but mid-year, both consumer and business sentiments plunged sharply, and associated economic uncertainties worsened as months passed. RBI, which initially projected GDP growing 7.4% in February 7, 2019, scaled down gradually to 5% by December 5, 2019. Final growth estimates turned out much weaker—a mere 4% as per the first revised estimates in January 2021.
RBI’s annual report for FY19, while analysing the growth slowdown midway in FY20, had raised an existential question: Was the Indian economy undergoing a soft patch, or a cyclical downswing, or a structural slowdown? Regrettably, a year later the central bank’s annual report for FY20 simply glossed over the structural question. Its emphatic conclusion—that the 2019-20 downfall was a confluence of global and domestic cyclical forces (Para I.9)—seemed less convincing. Similarly, the Economic Survey 2019-20, had argued that growth would rebound in the year’s second half (Para 1.11, chapter 01, Volume II) but a year later, the Economic Survey 2020-21 altogether overlooked as to why it didn’t. These reviews could have examined if the slowdown was cyclical, why did supportive fiscal-monetary policies fail to reverse the downswing in spite of economic slack.
Since there were no unanticipated external, or domestic, economic shocks in FY20 as in FY09 (global financial crisis), such a large forecast error—340 basis points, no less— should have elicited a critical analysis if structural sources caused the slowdown. As noted, this was an outcome of deceleration in three major expenditure, or demand-side, components of real GDP, viz., private final consumption expenditure (PFCE), gross fixed capital formation (GFCF) and exports. However, most analysts flagged the sharp braking of private consumption as the concerning factor. Was the slowing of private consumption in FY20 temporary? Was it heightened by some idiosyncratic events such as new emission and axle norms coupled with NBFC credit decline as noted by RBI’s FY20 report?
An early assessment would be difficult because Covid has distorted demand patterns, e.g., supply-chain problems leading to semi-conductor chip shortages have impacted car manufacturing, so it is hard to gauge if car sales will revive soon while the comparative fall in two-wheeler sales points to structural distress in rural segments despite robust agriculture growth.
Contrarily, the visible stresses in households’ pre-Covid balance sheet appeared more structural. The latest national accounts data reflected consumers’ preference to retire debt over current consumption. Indeed, households’ financial liabilities (nominal) contracted 14.7% in FY20, after an astounding 60.2% growth in 2017-18 that was near-threefold increase over 21.6% in FY17, the demonetisation year. If consumers continue balance-sheet repairs just like banks and corporates have been doing from 2011-12, growth revival would take a while. This should not be surprising because the prolonged private investment shortfall impacted job creation and income growth, thereby retarding consumption.An obvious follow-up question is why did this take so many years to surface? The answer would be that consumers did not reduce current consumption because future income expectations were buoyant. Some even expanded or sustained consumption through new borrowings, partly captured by the sharp increase in NBFC loans after demonetisation. The party was headed for a crash, just as the bank credit boom in infrastructure did in 2011-12. Confronted by weak future income prospects, sentiments plunged in mid-2019, prompting cutbacks in current consumption.
Another factor weighing strongly in this direction could have been terms-of-trade reversal: We know that global commodity prices’ collapse, including petroleum and foods, provided significant boost from 2014-15. These gains were large, persisted for several quarters, and coincided with low CPI inflation. But once that phase passed, inflation, especially core inflation, crept back. Indirect tax hikes, e.g., GST, excise, custom duties, worsened matters, eating into purchasing power and denting consumer confidence.
In which case, the most relevant question is if consumer demand is poised to revive. Little evidence of this is sighted so far. Real credit by banks and NBFCs has hardly grown. At the macro level, the sense is that both producers and consumers have exploited ultra-loose monetary policy for mending balance sheets—corporates have repaid or swapped loans with cheaper funding, households have also been retiring debt.
If businesses do not see demand, why should they invest? Optimists note that supply-side reforms of pre-Covid years such as IBC and GST have begun to yield results, while more structural reforms have been announced or implemented during Covid. This should boost consumer sentiment. RBI’s consumer expectation surveys do not reflect any great enthusiasm; they are rising once more, but from their Covid-lows, with the pace rather lukewarm. Recent decisions to rollback reforms or delay implementation don’t help. With terms-of-trade turning negative alongside pandemic-led damages to supply chains, elevated inflation threatens to harm consumer confidence further. Little, if any, fiscal space is left with government while RBI may be compelled to tighten monetary policy sooner.
Finally, the deeper and least-examined question has been if damages to the informal economy following demonetisation and GST contributed to the consumption slowdown with a lag. There’s no data to substantiate any further! If Covid is weakening already-fragile household balance sheets, the economy would face serious headwinds from demand constraints. Getting back to a higher growth trajectory could then be a distant, long-term call.
The author is New Delhi-based macroeconomist