The immediate fiscal deficit dynamics and growth outcomes for India post Covid-19 lockdown have been the subject of intense analysis and discussion. The human crisis of lives and livelihood did demand both an immediate and urgent response. With the lockdown now opening and economic activity picking up, it is important to look beyond FY21 to see how India could fare in the first half of the next decade.
Discussions have focussed on whether the economic recovery will be L, U, V, W, or a swoosh, a la the logo of a famous sports brand. These descriptors refer to the shape of the chart when plotting real GDP (on y-axis) over time (on x-axis). The GDP in FY20 is estimated to be Rs 204 trillion (Rs 204 lakh crore) and if it had continued to grow at 8% in real terms, GDP would have reached Rs 300 trillion by FY25. Depending on the inflation trajectory, the nominal number would have been higher. This then is the baseline chart.
An L-shaped recovery means that there is a sharp displacement from the trend line: this displacement is large and possibly growing compared to the baseline GDP over the next few years. A U-shaped recovery means that there is a gap in the output compared to the baseline over the next few years but the catch-up brings the GDP back to trajectory but this takes, say, the next 4-5 years. A V-shaped recovery means that the sharp fall from the trend-line is reversed in the next year or two. A swoosh can be a U or an L such that the recovery is asymptotic to the trend line: it tries to reach the trendline but never does. W is a scare-scenario: this is the virus coming again and causing the economy to go through varying intensities of L, U, V or swoosh again.
No one knows which of these scenarios will play out. The best that can be done is to describe these scenarios in some detail, assign probabilities based on judgment or expertise, and be ready to reassess the scenarios and probabilities as new information comes in. All economic agents can try to be ready to prepare themselves to react to the emergent scenarios. The government can try to trigger an outcome on the back of their fiscal and reform policies.
Moving beyond GDP
Employment and inequality
Employment, from both a stock and a flow perspective, will be determined by the shape of the recovery. In the near few quarters, depending on the severity of the economic shock, there will be a dent in the stock of people who are currently gainfully employed. Some part of this employment, in sectors and units that are most vulnerable, may simply never come back. The pace of job growth was anyways lower than what was required even before the Covid-19 lockdowns and slowdown: if the job growth remains anaemic, this will add to the stock of those who are not able to find jobs.
A V-shaped recovery is hence the best outcome if it can be engineered. An L or a long-U or a swoosh can leave many families out of the employment market. Lack of jobs takes away the ladder that many millions used to climb out of poverty. For those who are not able to build their ‘digital cocoons’, this can keep them deprived of a decent life and future for longer.
Fiscal and debt dynamics
There is a circular loop between the shape of the recovery and fiscal dynamics. A large expansion in fiscal spending can create a sharp recovery: this worked during the Great Financial Crisis in India when India ‘de-coupled’ with the rest of the world, continuing on its growth trajectory for longer. It did eventually lead to challenges in inflation and slow growth, and there are some lessons to be learnt there.
The current discussions concentrate on what the fiscal deficit-to-GDP ratio for FY2021 can be—however, it is important to look beyond to see how both the components of the equation behave. If the GDP growth does not pick up (L, long-U, swoosh), the ratio will continue to remain large. Fiscal deficits cumulate into the debt of the country. If the rate of addition to the debt stock of the country is larger than the rate of growth, debt as a proportion of GDP will continue to increase. This will have consequences on (1) growth rates thereafter (research suggests that countries with high debt-to-GDP ratio find it more difficult to grow), (2) credit rating of the country, and (3) the interest rates in the economy.
Exchange rate and $5 trillion
The world is awash – once again – with more capital being churned out by central banks. Currencies will take time to find their levels: their nature of trade and capital flows, debt on the country, the strength of its reserves, how the inflation dynamics play out, will all play a role in determining where exchange rates finally start to settle. Low prices of oil can help strengthen the rupee but an outflow of capital, on account of change in confidence or credit ratings, can weaken it.
We started this article by reference to a ‘real’ GDP of Rs 300 trillion by FY25 in the base case scenario, without Covid-19. If the rupee appreciated against the dollar, there was a possibility that India could reach the$5 trillion GDP target. Given the shock to the GDP and the uncertain direction of the exchange rate, it is reasonable to expect that the $5 trillion GDP will take longer. The$5 trillion GDP, at a population of 1.4 billion, would have meant a per-capita income of more than $3,500.
There are real consequences to the lives of millions of Indians based on the shape of the recovery. What jobs they find, what lives they lead and where, what they pay to access loans, how their incomes compare to the rest of the world, depends on how quickly we put Covid-19 behind us. A sharp V-shaped recovery can keep the medium-term economic trajectory of India intact—this will require significant investments from the government.
Head, Strategy and New Initiatives, Axis Bank. Views are personal