September 8, 2020 8:17:00 am
The revelation that GDP has shrunk by nearly 24 per cent confirmed that the damage to the Indian economy was amongst the most severe globally, write Sonal Varma and Aurodeep Nandi, economists at Nomura.
Why did India perform so badly relative to other countries?
First, India had one of the world’s most draconian lockdowns. Second, unlike other countries, India was far more parsimonious in its fiscal response.
Third, the economy was in a classic balance sheet crisis before the pandemic began. The major engines of growth — consumption, investment, and exports — had been decelerating since the end of 2018. The pandemic aggravated the already frayed finances of corporates, banks and shadow banks.
While we may estimate a sequential improvement in GDP growth in the second quarter, there is likely to be another massive contraction of (-) 10.4 per cent. Growth is likely to remain in negative territory for the next two quarters, clocking in at (-) 5.4 per cent in Q3 and (-) 4.3 per cent in Q4, averaging (-) 10.8 per cent in 2020-21.
What does this mean for policy?
“The precipitous fall in growth should serve as a grim reminder of the cost of having an excessively cautious fiscal response,” they write. “Left unchecked, a longer period of below-normal activity risks the knock-on effects on the labour market, MSMEs and ultimately on the banking system.
Monetary policy has over-delivered, and with a bout of high inflation effectively hamstringing the RBI from cutting policy rates further in the near term, “the ball is in the fiscal court”.
This could involve cash transfers and public employment programmes in urban areas, among other support measures, they write.
The elephant in the room is the limited amount of fiscal support offered so far — presumably due to concerns over the fiscal space.
So far, the RBI has focused on support via liquidity in secondary markets and other regulatory measures to bring yields down, flatten the yield curve, and incentivise banks to buy more government paper.
“If these fail, debt monetisation, as Indonesia has already done, might be the second round of defence,” they conclude.
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