Blind optimism on GDP growth

The severity, penetration and pervasiveness of the second wave of the Covid pandemic the raises new questions on the optimism of the authorities in India as also of the multilateral institutions like the IMF and ADB on growth revival, particularly the projection of a 10.5 per cent increase in real GDP in 2021-22 over the previous year.

It is easy to see how and why this is not achievable, for certain. A growth of 10.5 per cent means the India’s real GDP must grow from ₹134,08,882 crore (official 2020-21 figure) to ₹148,16, 815 crore, an increase of around ₹14-lakh crore. We have not achieved this in the best of times. To say we will do it now is but blind optimism that hinders rather than helps any analysis that must guide policy in these difficult times.

Our economy since 2011-12 (inception of the new GDP series) has only recorded increases in the range of around ₹5-lakh crore in 2012-13 and about ₹10-lakh crore in 2016-17. Given the real GDP break-up into private final consumption expenditure (PFCE), government final consumption expenditure (GFCE), gross fixed capital formation (GFCF) and net exports (export minus imports), what could be the contribution of each of these items to give us an additional ₹14-lakh crore?

PFCE, or private consumption has four components — durable goods, semi-durable goods, non-durable goods and services. Save non-durables, all are in the midst of a phase of contraction, which is a trend that can only be aggravated by the current round of local lockdowns. Similarly, the private sector contribution in the process of capital formation (or investments) looks gloomy going by the recent trends coupled with lockdowns and reported reverse migration of semi-skilled and unskilled workers, who remain the backbone of the production process. This is particularly so of the transport and construction sectors that have the maximum forward and backward linkages relating to the manufacturing sector.

Let us look at final consumption and capital formation (investment) by the government. The Union Budget 2021-22 has estimated a fiscal deficit (net borrowing requirements) relative to GDP at 6.8 per cent on top of 9.5 per cent in the previous year to meet the expenditure requirement. On account of this, there could be some enhancement in government consumption and investment. However, these developments need to be seen in the context of a large revenue deficit (5.1 per cent of GDP in 2021-22 and 7.5 per cent in 2020-21) along with a record level of fiscal deficit at 6.8 per cent and 9.5 per cent since the inception of FRBM Act in 2003.

In the context of India’s budgetary practice, the revenue deficit essentially is incurred to meet the current consumption of the government. In an operational sense, the revenue deficit is the dis-savings of the government administration. In addition, household financial savings have also recorded a down-swing.

According to an RBI study (RBI Bulletin March 2021), preliminary estimates for Q2:2020-21 indicate that the household financial savings regressed closer to the pre-pandemic levels to 10.4 per cent of gross domestic product (GDP) after touching an unprecedented high of 21 per cent in Q1:2020-21. This reversion, as the RBI study further observed, is mainly driven by the increase in household borrowings from banks and NBFCs. Further, preliminary indications suggest that the household financial savings rate may have gone down further in Q3:2020-21 with the intensification of consumption and economic activity. Thus, from the savings-investment angle also, there is a grave suspicion about projections of such a high magnitude of economic growth revival.

Monetary policy stimulus

Another important aspect with regard to growth revival is the front-loading of the monetary policy with an accommodative stance coupled with the introduction of unconventional monetary policy instruments like LTRO (Long Term Repo Operation), TLTRO (Targeted Long Term Repo Operations), OMO twist operation (simultaneous purchase and sale of government securities in the Open Market Operations) and the G-SAP (government securities purchase from the secondary market), which is broadly similar to Quantitative Easing.

According to an RBI study (RBI Bulletin April 2021), this G-SAP commits the RBI upfront for the first time to the acquisition of a specified amount of government securities in a specified period of time. The RBI study further observed that G-SAP helps market participants plan their engagement with the borrowing programme better. The RBI claims it is not monetisation of the budget deficit as it involves only secondary market operations. In what is a case of misplaced euphoria, the above study describes G-SAP as the ‘ brahmashtra ’ deployed by the RBI governor, unmindful perhaps that weapons of this order, even mythologically speaking, are destructive and can wipe out more than they set to fix.

Let us have clarity on monetisation and mortised budget deficit. With the introduction of Ways and Means Advances (WMA) Scheme for the Central Government on April 1, 1997, we bid goodbye to automatic monetisation or monetisation of the budget deficit but by this dubious financing of the fiscal deficit through the balance-sheet approach by purchasing assets and printing money, the RBI engages itself in monetisation.

In short, this is nothing more than printing money to hand it over to the government to go on a large spending spree to kick-start the economy, with its own implications of the fallout in terms of inflation, fiscal discipline and rectitude and the real benefits this may offer when national strategic priorities are not set and the nation is essentially muddling through a war with an invisible enemy in the form of a deadly mutant virus.

The authorities may be reminded of the famous “unpleasant arithmetic” by Sargent and Wallace, who argue in their famous 1981 paper and establish that even when inflation is prima facie a strictly monetary phenomenon (prices are flexible, markets clear and velocity is constant), yet inflation is, in the long run, always and everywhere a fiscal phenomenon.

0n the inflation front, the headline Consumer Price Index Combined (CPI-C) has been above the average inflation of 4 per cent as mandated in the Flexible Inflation Targeting (FIT). The core inflation (which is measured by netting out food and fuel inflation from the headline inflation) is above 5 per cent indicating the strong possibilities of persistence of inflation potential. The inflation situation could aggravate further in the second wave of the pandemic on account of the lockdown with disruptions in the supply chain.

To conclude, the second wave of the pandemic is deadly. There is no time to praise and pat ourselves on the back. All stakeholders should work together, including citizens of the country, to fight against the pandemic. Now, it is not a question of lives or livelihoods but life and livelihood together. This is no time for unbridled, blind optimism.

The writer, a former central banker, is a faculty member at Bhavan’s SPJIMR. Views are personal. Through The Billion Press

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