India’s record contraction last quarter sets back economic progress by several years and puts Prime Minister Narendra Modi’s ambitious targets of doubling the economy’s size to $5 trillion almost out of reach.
The 23.9% decline in gross domestic product in the June quarter from a year ago — the biggest of major economies tracked by Bloomberg — prompted banks like Nomura Holdings Inc. to downgrade their full-year forecasts for this year to -10.8%. It also shifts the focus back to the government and central bank on what steps can be taken to spur growth.
What’s the impact on India’s long-term growth?
In the past, India has managed growth rates of more than 8%, but that’s steadily eased in recent years following a crisis among shadow banks that hit lending and consumption in the economy. The economic damage now caused by the coronavirus pandemic will last well beyond the current outbreak. Banks are cautious about lending, fearing a jump in bad loans, while businesses have curbed borrowing and investments, dragging down demand.
Pranjul Bhandari, chief India economist at HSBC Holdings Plc in Mumbai, sees the pandemic leaving behind an “economic scar,” with potential growth falling to 5% from 6% before the virus outbreak. Deutsche Bank AG’s chief India economist, Kaushik Das estimates the potential growth rate could drop to 5.5%-6% from about 6.5%-7% earlier, though foreign inflows could continue as nominal GDP growth recovers toward double-digits. Past recession experience suggests “it typically takes roughly five to 10 years for real economic activity to reach its former peak level,” said Soumya Kanti Ghosh, chief economist at State Bank of India.
What does it mean for job creation and poverty?
Even at 5% growth rates, India’s economy wasn’t expanding fast enough to generate jobs for the more than 10 million young people who enter the workforce each year. The pandemic has now destroyed jobs and pushed millions of people into poverty. The Center for Monitoring Indian Economy, a private think tank, estimates that as many as 18.9 million salaried Indians, or 21% of the overall workforce, lost their jobs between April and July, along with nearly 7 million daily wage earners — like hawkers, roadside vendors and construction workers. The World Bank estimates that nearly 12 million Indians will be pushed into abject poverty in a country where over a fifth earn less than $2 a day.
What can the central bank do?
The Reserve Bank of India has carried the bulk of the stimulus burden for the economy. It’s cut interest rates by 115 basis points, pumped money into the financial system through liquidity operations like bond purchases and Operation Twist, and transferred billions of dollars in dividends to the government. On Monday, the central bank took additional steps to support the bond market, giving lenders more leeway to hold government securities without marking them to current lower prices and announcing plans to pump in billions of dollars in extra funds.
When it comes to conventional monetary policy, there’s limited scope to do more. Banks have been slow to pass on the RBI’s rate cuts to consumers, mainly because of the overhang of bad debt, leaving credit growth languishing. And with inflation exceeding the 6% upper limit of its target band, the central bank is taking a more cautious approach to easing.
What fiscal options are available?
The government outlined 21 trillion-rupee ($282 billion) worth of measures to support the economy through the virus crisis, but most of the steps were focused on providing credit support to small and mid-sized businesses rather than giving direct assistance, like tax cuts, to consumers to boost demand in the near term. Some economists argue that the government should provide a universal basic income grant and the RBI should finance the fiscal deficit, which is expected to reach more than double the government’s original target of 3.5% of GDP this year. The government though is wary of the implications on its credit rating at a time when it’s trying to open the bond market to more foreigners.