Covid-19: Another blow to India’s economy

Ramkishen Rajan/Sasidaran Gopalan | Updated on March 30, 2020

India’s financial distress was exacerbated by the pandemic. With limited fiscal space, the onus for economic revival rests with the RBI

The constantly evolving Covid-19 pandemic has cast a long shadow on the global economy, which was already jolted by the US-China trade war . With fears of a global recession on the horizon, Covid-19 appears to have dealt the global economy a triple-whammy: massive supply-chain related disruptions across a range of industries from containment efforts in China and other economies; amplification of demand-side shocks due to uncertainties as well as lockdowns and other containment measures domestically; and propagation of financial shocks and the US dollar credit crunch.

This global shock comes at a particularly inopportune time for India, as the economy was already on a very concerning downward trajectory since the turn of FY 2018-19 (Chart 1). More specifically, on a quarterly basis, India’s growth rate fell from around 8 per cent in Q4 FY18 to a new low of 4.5 per cent in Q2 FY20.


Indeed, in its January 2020 update to the World Economic Outlook, the International Monetary Fund (IMF) downgraded India’s growth estimates for 2019 to 4.8 per cent — the lowest for over a decade — and sharply revised its 2020 growth forecast to 5.8 per cent, down 1.2 percentage points from the previous forecasts. These downgrades happened even before the onset of the pandemic, and now look overly optimistic.

The roots of India’s economic drag in recent years can be traced back to the aftermath of the drastic demonetisation experiment, which led to significant collateral damage, and the effects of the rollout of the GST. While both these supply-side measures may have been well-intended, they have certainly contributed to marked economic disruptions and led to a deeply entrenched slowdown in the informal sector.

This has, in turn, been exacerbated by acute banking sector problems, with banks being saddled by non-performing assets (NPAs) partly driven by “crony capitalism” stemming from the close nexus between banks and large “politically connected” businesses, giving rise to dubious lending practices and bad loans. Added to these banking woes has been a generalised credit crunch in the financial system due to stresses in the non-bank financial sector, especially following the collapse of Infrastructure Leasing & Finance Services (IL&FS).

On the external front, India’s economic struggles have been somewhat complicated by the uncertainties triggered by the US-China trade war. Although India’s relatively limited presence in the global value chains (GVCs) allowed it to be somewhat insulated from the trade war, it was nevertheless a missed opportunity to benefit from potential investment diversion from China. India’s inability to exploit investor interest in looking beyond China (as Vietnam has, for instance), is a failure of the country’s flagship “Make in India” initiative which seems to be becoming an excuse to revert to a degree of protectionism rather than of enhancing export competitiveness per se.

Impact of Covid-19

The immediate economic and market impacts of the coronavirus have been on India’s financial markets as well as the rupee, which hit a new low vis-à-vis the US dollar in March due to global risk-off sentiment (Chart 2). For firms laden with dollar-denominated debts, a continuous weakening of the rupee is likely to intensify their struggles to repay their obligations. Beyond the financial shocks, India has to urgently find a way to cushion the demand-side shocks induced by potential lockdowns and other ongoing containment measures.


Although the recent drop in oil prices offers some reprieve, it is inevitable that India will have to undertake more aggressive counter-cyclical fiscal measures at some stage to buffer against acute negative shocks arising from the spread of Covid-19.

With the escalating number of infections, even after the self-imposed janata curfew experiment on March 22 across the country, 30 States and Union Territories have now announced a complete lockdown as a means of flattening the pandemic curve. Such a prolonged lockdown in the near future is likely to be economically costly, with the brunt of the pain falling disproportionately on those in the informal sector.

Further, a country-wide lockdown in and of itself may not prove sufficient to stop large-scale community transmission, as the virus can make a comeback once such restrictions are lifted unless eradication efforts are complemented by extensive testing measures and a rigorous follow-up in terms of aggressive contact tracing and subsequent targeted isolation.

Indeed, such strategies have so far been successful in helping countries like South Korea and Singapore. As the Foreign Minister of Singapore Vivian Balakrishnan remarked recently, Covid-19 is “an acid test of every single country’s quality of healthcare, standard of governance and social capital. If any one of this tripod is weak, it will be exposed, and exposed quite unmercifully by this epidemic.”

Macroeconomic policy

Although an appropriate fiscal response is imperative to uplift the economy and especially assist the most vulnerable, a massive fiscal expansion of the type envisaged by many other countries is likely to exceed the fiscal targets set by the FRBM (the reprieve provided by low oil prices notwithstanding). This would imply that the government has to either invoke the escape clause or ignore the rule temporarily with the hope of returning to a path of fiscal consolidation once the Covid-19 storm has been weathered.

Given the limited fiscal space India has compared to its East Asian counterparts, the onus may well fall on the Reserve Bank of India (RBI) to do more heavy lifting in these times of growing economic distress. To that end, the Central bank has also taken some steps to ease the dollar credit crunch via long-term repo operations (LTRO) and offered a $2-billion swap for six months to ease the pressure on the rupee, although it has not been part of the coordinated action by central banks in taking even more aggressive measures to counter the heightened volatility and adverse economic fallout from the coronavirus.

Even if the RBI rolls out more aggressive measures, the broader concern that still remains is the inadequate monetary policy transmission that limits the effectiveness of any monetary stimulus in India, especially in the context of an impaired financial sector.

One can only hope that the acute economic challenges already faced by the country, which will only be exacerbated by the Covid-19 pandemic, will persuade Prime Minister Modi’s government to refocus its priorities towards dealing with economic stabilisation and upliftment rather than pursue the more controversial aspects of its social and political agenda. The need of the hour is unity of purpose.

Rajan is a Yong Pung How Professor at Lee Kuan Yew School of Public Policy, National University of Singapore. Gopalan is Senior Research Fellow at the Nanyang Business School, Nanyang Technological University

Published on March 30, 2020

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