Contradictions in the present crisis

• India registered negative economic growth in 1972-73, 1965-66 and 1957-58.
• All these were drought years.
• 1957-58 also registered a significant balance of payments (BOP) deterioration and 1979-80 witnessing the second global oil shock following the Iranian Revolution.
• Farmers harvested a bumper rabi crop last year and public cereal stocks at 94.42 million tonnes as on July 1 were also 2.3 times the required level.
• There’s no shortage today of food, forex or even savings.
• Foreign exchange reserves were at an all-time high of $538.19 billion.
• So, the real GDP decline of 5-10 per cent for 2020-21 would be the country’s first-ever not triggered by an agricultural or a BOP crisis.

“Western style” demand slowdown in India

• What India has been going through is a full-fledged recession bereft of consumption and investment demand.
• Households have cut spending.
• The same goes with businesses. Many have shut or are operating at a fraction of their capacity and pre-lockdown staff strength.
• This demand-side uncertainty and the resulting economic contraction is something new to India.
• Banks are also facing a problem of plenty.
• While their deposits are up 11.1 per cent, the corresponding credit growth has been just 5.5 per cent.
• At some point when all this reduced spending and investments leads to a further contraction of incomes, it is bound to reduce savings as well.

Why the government is not spending?

• Solution in such a situation is the spending by the government.
• There are three probable reasons why government isn’t doing that.

1.Optimism

• Hope that once the worst of the pandemic is behind us, people will start spending and businesses, too, will spring back to life.
• However, this assumes the economy wasn’t doing all that badly previously and that the lockdown hasn’t caused too much of permanent damage.
• The truth is that growth had already slid to 3.9 per cent in 2019-20.

2.State of Government finances

• In 2007-08 global financial crisis, the Centre’s fiscal deficit was only 2.5 per cent of GDP, whereas it stood at 4.6 per cent in 2019-20.
•  The space for a fiscal stimulus, in other words, is very limited compared to that time.

3.Sustainability of debt

•  Between 2007-08 and 2019-20, the Centre’s outstanding debt-GDP ratio has come down from 56.9 to 49.25 per cent.
• So has general government debt, which includes the liabilities of states, from 74.6 to 69.8 per cent.
• Economists such as Olivier Blanchard have shown that public debts are sustainable provided governments can borrow at rates below nominal GDP growth (i.e. GDP unadjusted for inflation).
• The nominal GDP averaged 11.1 per cent during  2014-15 to 2018-19.
• As against this, the weighted average interest rate on Central government securities ruled between 6.97 per cent in 2016-17 and 8.51 per cent in 2014-15.
• Only with nominal GDP growth falling to 7.2 per cent in 2019-20, and most likely zero this fiscal, has the Blanchard debt sustainability formula come under threat.

Way forward

• Government can take lessons from the Vajpayee period when the weighted average cost of Central borrowings more than halved from 12.01 per cent in 1997-98 to 5.71 per cent in 2003-04.
• In the last four months, yields on 10-year Indian government bonds have softened from 6.5 to 5.9 per cent and even more for states — from 7.9 to 6.4 per cent.
•  Interest rates will fall further as banks have nobody to lend to.

Consider the question “Examine how covid induced economic recession is different from the past recessions? What are the options with the government to deal with the situation?” 

Conclusion

Governments should borrow and spend. They need worry only about GDP growth, real and nominal.

Sources: https://indianexpress.com/article/opinion/columns/a-crisis-without-villains-6557602/

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