Economy will shrink by just 6-7 per cent: C Rangarajan

Our Bureau Chennai | Updated on November 10, 2020

Dr C Rangarajan   -  Nagara Gopal@The Hindu

Capital expenditure has stronger forward and backward linkages than other types of expenditures


If there is one economist who has seen it and experienced it all, it is Dr C Rangarajan, former RBI Governor & former Chairman, Prime Minister Economic Advisory Council. Whether it was the monumental reforms of 1991 or the 2008 global financial crisis, he was at the forefront. He spoke on India’s present economic crisis during a conversation with Raghuvir Srinivasan, Editor, BusinessLine, at the BusinessLine Knowledge Series webinar on ‘Is India’s Economic Recovery Sustainable?’. Excerpts:

A lot of indicators point to a recovery. Is the ongoing economic recovery sustainable ?

First of all we need to understand the nature of the current problem. The economic crisis that we are facing is different from the economic crisis that we have faced earlier.

This is the first economic crisis which has been triggered by a non-economic factor — a pandemic. It is the attempt to prevent the spread of the virus through such measures as lockdown which has resulted in the economic activity coming to a grinding halt.

To me, the removal of lockdown or reducing the restrictions to a drastic extent is a necessary condition for economic growth.

In the first quarter, the GDP fell by 23.9 per cent and that is the period in which we had the most severe lockdown. Now, as we move away, it is quite possible for the economy to pick up.


My view is that, possibly the second quarter will also have negative growth. Perhaps, it may be half of what it was in the first quarter.

During the next two quarters, I believe the economy will start picking up and we may end the year with a rate of growth, which will still be negative for the year as a whole, but less than what has been projected in some quarters like minus 10 per cent and so on. Maybe minus 6 to 7 per cent is a possibility. The big question, however, is that there should be no resurgence of the virus.


Our economy was not in the pink of health in run-up to the pandemic...

I agree with you. That is why I am using the word ‘recovery’ in a very cautious way. Recovery is not really beyond the 2019-20 level. Even that year had a slowdown with only a 4.2 per cent rate of growth. We have lost one half of the year but the second half year, we may be able to compensate a little bit and reach the level of 2019-20.

What do you think the Centre should do to ensure that recovery sustains not just for the second half of the year but into the next fiscal as well ?

The usual argument is that in a weak demand situation there is a role for the government. That is to increase the government expenditure which is a traditional Keynesian argument that is always put forward and I suppose it is correct.

In fact, the traditional Keynesian argument does not make any distinction between one type of expenditure from the other. That is why the famous saying ‘digging the holes and filling them back up again’ also became popular.

But I think we need to move away from that. I think there is a need for government expenditure to sustain the demand at a particular level.

Here, I have a view that the government should raise capital expenditure.

Capital expenditure has stronger forward and backward linkages than other types of expenditures. Government of India should come forward with good programme of investment expenditure of not only government but also of PSUs. That will actually pull the economy much more than anything else.

The government has already announced an infrastructure pipeline and I think there should be a pipeline by PSU units and put together may be 2 per cent of GDP must be spent on capital expenditure. I think that will be the real step forward in pulling the economy.

The trajectory of inflation is now trending towards 6-6.3 per cent. Are you happy with that?

The inflation that we are seeing now has to be seen not just in the context of demand-supply imbalances but also in the context of what we are doing overall in order to be able to push the economy forward.

One thing that the government is talking about is to increase the liquidity of the banking system so that it may be in a position to provide credit. Later on, the RBI has to help the government if it is going to borrow to sustain the high levels of expenditures.

Therefore, a lot of liquidity is being pushed into the system. I believe that inflation will come down a little bit but not to the level of 4 per cent.

Pumping liquidity does not necessarily mean the money supply also increases because it all depends upon what the banks do with the liquidity that has been given to them. If they really lend and if they are in a position to give credit in a larger way then money supply will increase otherwise it won't. I do not know at this point how aggressively the banks will lend or the bank themselves will find adequate borrowers.

We are essentially in a situation where liquidity is increasing but output is not increasing. That way we will end up with some inflation but may not necessarily be at this level. It may be at 6 per cent level.

Would you be comfortable with 6 per cent inflation level?

None would prefer that level of inflation and in the long run it is not a good policy. Perhaps one would have to tolerate the level of inflation which is not ideal but much higher. Therefore, we may be able to live with that considering the very special situation that we are placed in.

Are you comfortable with the accommodative stance of monetary policy of the RBI?

Accommodative monetary stance is perhaps warranted by the situation in which we are placed.

The economy is going down. We are even talking about a negative growth rate which is unheard of in the recent period. Therefore, to some extent we really have to take care of the situation and I do not fault with an accommodative monetary policy. But I have two concerns: One is the impact on inflation.

The monetary authorities should take a stand on how far they will be willing to let the inflation go. Secondly, the increase in the Reserve Money (RM), which is what the actions of the central cank results in, will lead to an increase in money supply only when the banks begin to lend.

There are two points here the monetary authorities should be careful of : When we require all the banks to lend, I think we need to be somewhat careful about it. I think there is a need to ensure that banks lend in this situation but we also have to be careful because it should not become a burden. Loans of today should not become NPAs of tomorrow.

Where do you see the fiscal deficit by the end of this year?

The Government indicated a fiscal deficit of 3.5 per cent of GDP in its Budget. Many people, while discussing the Budget, had some doubts about even the credibility of that number. After that Covid happened. A colleague of mine and I did a calculation. You are really looking at 14 per cent of GDP. It is very high but I have come to a reluctant conclusion that it is unavoidable and we really have to live with it this year. We need to see how we can slowly slide it down without harming the economy.

If there are three immediate reforms that the government should embark upon in the next six months to a year, what should they be?

I will list three sets of reforms. One, in the financial system, particularly with respect to banks.

I personally think that the banking system cannot carry forward with this load of NPAs and therefore recapitalisation has to be looked at more exhaustively in a more expanded way.

At the same time, the key question is why are we getting into this situation? We have been recapitalising every year from 1991 onwards so we should not get into this situation.

This raises a critical question, what is the relationship between public sector banks and the government. What is the kind of relationship that we should establish to enable the public sector banks to function independently?

The second suggestion is that we need to look at reforms of specific sectors rather than general in nature.

For instance, reforms for the power sector, telecom sector. These are the areas where some considerable thought has to be given and we basically need to apply the principle of liberalisation to every sector.

Third, is what I call governance reforms. Government always talks of ease of doing business but what is ease of doing business with the government, which is equally important.

I really think that we moved away from the system saying that controls are coming in the way of efficiency but we should not move to a situation in which regulations simply substitute controls.

Too many regulations come in the way of innovation and too little regulations creates instability and therefore we need to strike a balance between the two.

Let us take some questions from audience...

Radhika Merwin: How do we address the issue of lost GDP?

Lost GDP has to be compensated by higher growth in the subsequent years but as far as the individual units are concerned, if they are closed, it is going to be very difficult to reopen them. I think the time has come to revive the kind of development banks that we had before.

We thought the bond market will replace the development banks and the long-term capital will come through the bond market but that has not happened.

Tony: If lowering the GST for a short while can help consumption and recovery, what’s the government's concern for this approach?

I think the government’s concern is that it does not have enough revenue.

Compensation has come in because of the fact that you are not collecting as much revenue as you have collected before and people are saying there is a shortfall.

It is not that the government is now collecting more revenue through GST than what was existing before GST. Therefore, the whole question of lowering GST further does not arise.


Published on November 09, 2020

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