ExplainSpeaking: When and how will Indian economy recover, what the shape of its recovery will be?

Before taking a stab at the answer, here is a quick look at the possible scenarios of recovery.

It is important to understand the factors that determine the shape of recovery. These include the overall duration of the pandemic, the effect on jobs and household incomes, the extent of fiscal stimulus provided by the government etc.

For instance, if the economic disruption was just for a small period wherein more than people’s incomes, it was their ability to spend that was restricted, then when the lockdown opened, it is possible to imagine a “Z”-shaped recovery (see graph; source: Hutchins Center of Fiscal & Monetary Policy at Brookings).

In this, the GDP — and here we are talking about absolute GDP, not GDP’s growth rate — actually overshoots the trend path because of the pent-up demand. Imagine, deferred parties, salon visits, movies, purchase of new cars, houses and appliances etc. — all of them get bunched up together.

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But what if the economic disruption lasts longer resulting in several activities being forgone instead of being deferred? For instance, all the summer vacations in Europe that won’t happen this year. Or, even the monthly haircut — when you go to the salon after 3 months, you have already lost 2 haircuts-worth of economic activity forever!

In such a scenario, and assuming incomes and jobs are not permanently lost, the economic growth recovers sharply and returns to the path it was following before the disruption. This is called a “V”-shaped recovery.

But what will happen if this recovery is slower and takes more time because the economic disruption resulted in several jobs being lost and people losing incomes, drawing down on their savings etc.?

Then the economy will follow a “U”-shaped path. In such a scenario, after the initial fall, the recovery is gradual before regaining its momentum. If this process is more-long drawn than it throws up the “elongated U” shape.

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Since we are talking about a Covid-induced disruption, it makes sense to also look at a “W”-shaped recovery as well. This shape allows for the possibility of a V-shaped recovery, which is pegged back by a second wave of infections until of course, the economy recovers for the second time.

The last scenario is the one policymakers most dread. It is called the “L”-shape recovery. Here, simply put, the economy fails to regain the level of GDP even after years go by. As the shape shows, there is a permanent loss to the economy’s ability to produce.

Coming back to what will happen to India. Most economists are unanimous that in the current financial year, India’s economy will contract. The difference of opinion is only about the extent of this contraction. The range varies between minus 4% to minus 14%. Many economists are of the opinion that after hitting rock bottom this year, the economy will start its recovery in the next financial year (2021-22).

But according to a detailed analysis by Pronab Sen, former Chief Statistician of India, that was published in Ideas for India over the weekend, India’s economy will contract not just this year but also in 2021-22.

The Table shows how India’s absolute GDP (in Rs Trillion, which is the same as Rs Lakh Crore) is likely to struggle to even come back to the 2019-20 level by 2023-24, which is the last year of this government’s current term.

The Table also provides a snapshot of the likely trend level of GDP had India grown at 6% and 8% respectively over the same period.

“As things stand, and the government retains the 2020-21 expenditure budget for 2021-22 as well, it is likely that 2021-22 will witness a GDP growth rate of -8.8%. This is a frightening thought since it means that the country could experience a full-blown depression – the first in our history as an independent nation,” writes Sen in his analysis.

As the last graph shows, given the weakness of the economy going into the Covid crisis as well as the less than adequate fiscal stimulus, India is likely to end up with an “elongated U-shape” recovery.

Stay safe.

Udit