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CAFE ECONOMICS

Opinion | Is India headed for its worst growth

recession in a decade?
4 min read . Updated: 20 Aug 2019, 10:39 PM ISTNiranjan Rajadhyaksha
It is risky at this juncture to bet merely on a natural recovery. Even so, using monetary policy
is the best option right now
Topics
Indian Economy
Much of the debate in recent months has been focused on the sharp loss of
economic momentum in India. The big question is whether the ongoing slowdown
is structural or cyclical.
The usual thumb rule is that the policy response to a structural slowdown is
through economic reforms that ease supply constraints. And a cyclical slowdown
has to be tackled with measures to stimulate demand. Rathin Roy of the National
Institute of Public Finance and Policy argues that India is currently facing a
structural demand problem, which further complicates policy choices.
Another way to look at the situation now is through the prism of a growth
recession. Economists define a recession as three consecutive quarters of
contraction. Economic growth slips into negative territory during a recession. A
growth recession is different. The economy does not contract. It continues to
expand, but at a sequentially slower pace.
India has had three such growth recessions in the past 10 years. The first episode
was in the immediate aftermath of the financial crisis that originated in the US.
Economic growth fell sequentially in the three quarters from June 2008, or the
second quarter of fiscal year 2009. The downturn was sharp, but short.
The second episode was after the effects of the 2009 stimulus wore off. Economic
growth peaked in the three months ended March 2011, but slowed for five
consecutive quarters after that. The policy paralysis during the last years of the
Manmohan Singh government also pinched.
India is now in the third growth recession since 2008. Economic growth has
already slowed sequentially for four consecutive quarters. It is very likely that
economic growth in the quarter ended 30 June will be slower than in the quarter
ended 31 March, at least going by the latest high frequency data, as well as various
forecasts by private sector economists. The most recent goods and services tax
(GST) collections data is also an indication of weak domestic demand, though the
fact that indirect tax collection is growing slower than nominal GDP growth could
also mean that demand that shifted to the formal sector after demonetization is
again moving back to the informal sector.
In other words, it is highly probable that the current growth slowdown matches the
one in the early years of this decade—though it could be shallower if one
calculates the loss in momentum from peak to bottom. India cumulatively lost 5.5
percentage points of quarterly growth between the quarters ended March 2011 and
June 2012. The loss in the current downturn is a relatively modest 2.6 percentage
points.
What now? Many private sector economists seem to be expecting a cyclical revival
after the third quarter of the current fiscal year. The average growth forecast of 32
professional forecasters polled by the Reserve Bank of India in July was 6.9%, a
modest 30 basis points lower than the average estimate of the previous poll.
However, it is likely that many have reworked their numbers since then, taking it
closer to 6.4%. But even that is higher than the most recent quarterly growth rate
and, hence, an indication that a modest growth recovery is expected later this fiscal
year.
However, it is extremely risky at this juncture to merely bet on a natural recovery
in economic growth. Slowdowns can feed on themselves through psychology, or
what Keynes famously called “animal spirits". The signs of a tentative recovery in
private sector investment have petered out. Consumer demand is weak, and the
mess in the shadow banking system means that households no longer have the
leverage option to maintain consumption in the face of slow income growth. The
trade war has crimped international demand for exports.
A lot is thus riding on the policy response. The one big difference between the
growth recession earlier this decade and the current one is that India has more
macroeconomic stability. The balance of payments is in better shape even though
the withdrawal of foreign money from the domestic capital market is a worry.
The biggest differentiator between then and now is inflation. It is under control,
creating space for an immediate demand stimulus. There is definitely more space
right now for a monetary stimulus rather than a fiscal stimulus. Total government
borrowing is already soaking up most of the annual financial savings of Indian
households, which is one reason why the government is trying to get access to
foreign savings via a sovereign bond. The fiscal deficit is anyway likely to expand
this year, given the unrealistic tax collection targets in the July budget, thus acting
as an automatic stabilizer.
Monetary policy is the best bet right now. However, it works with a lag of around
three quarters in India, which means that a rate cut today moves the demand needle
nine months later. So, the fiscal lever may have to be used as a last option in case
demand destruction continues. It should ideally be directed towards sectors such as
home building, roads and automobiles that have strong links with other parts of the
economy.
Finally, one brutal fact: If the Indian economy continues to lose momentum over
the next two quarters, then the country will be in its longest growth recession in a
decade.
Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai
Academy of Economics.