India’s macro-economic scenario in the post-Covid era represents a severe contraction of economic activity. The challenge facing the nation is unprecedented in many ways. Coupled with the uncertainty caused by a pandemic that is still taking a growing toll, more gathering clouds and a global scenario that is equally dismal, the nation has to brace itself for a long grind.

There is no easy way out. This much is clear from the data released by the National Statistical Office on Monday. Real growth in Q1 of 2021 measured in terms of GDP at constant prices (base 2011-12=100) is down 23.9 per cent over the corresponding period of the previous year. This is the first firm official data-led indication of the huge toll that the pandemic and the subsequent lockdown is exacting on the nation.

Large-scale contraction

A look at the components of growth show that collapse of investment (gross fixed capital formation declined by 89 per cent) and private consumption (down 36.4 per cent) are the key factors contributing to such a large-scale contraction. However, the government consumption expenditure increased by 16.4 per cent, indicating that we are in for a shocker of a revenue deficit, which is the root cause of a drag on financial savings in the system.

The supply-side growth connoted by gross value added (GVA) explains that negative industrial growth (manufacturing growth down 39.3 per cent accompanied by a contraction of 41.3 per cent in mining and quarrying), subdued agriculture growth (up 5.7 per cent) and a negative services growth overall contributed to a negative GVA growth of 22.8 per cent in Q1 of the current fiscal over Q1 2019-20. The negative services growth was mainly accounted for by a negative growth of 50.3 per cent in construction and a negative growth of 47.0 per cent in trade, hotels and transport services.

The growth numbers we see today are a mirror to negative investment demand coupled with a collapse in industrial growth. It is pertinent to note in this regard that this development is corroborated by the Q1 production data measured in terms of Index of Industrial production (IIP) released by the NSO earlier on August 11. As it may be seen from the IIP data, the production of capital goods representing the indicators of investment demand declined by 36.9 per cent in June, and cumulatively this led to minus 64.4 per cent growth in April-June 2020.

Another important aspect is the contraction in the construction sector — which exhibited a deep slump in the consumption of steel in July (minus 29.1 per cent in April and minus 57.9 per cent in April-June) — and the production of cement, which contracted by 6.9 per cent in June (down 38.8 per cent in April-June). According to the RBI Annual Report released on August 25, declining capacity utilisation, the weakening of consumption demand and the overhang of stressed balance sheets are constraining new investment.

Revival policies

Over the course of about five months since the Covid-19 pandemic struck, policymakers have chosen fiscal and monetary stimulus particularly, in the same manner as they did in the aftermath of global financial crisis of 2008- 2009. In India, as there is absence of fiscal space, monetary policy took precedence over the fiscal policy. The RBI through conventional and unconventional monetary policy instruments injected ₹5.76 lakh crore of liquidity (currency/cash) in 2019-20 and ₹3.09 lakh crore in current fiscal Q1.

Besides this, the policy repo rate was brought down by 250 basis cumulatively from February 2019 to date, of which 115 basis points was during March and May, 2020. By and large, the transmission of these rates to the bank lending rate has been low. However, on account of the introduction of unconventional monetary policy like the long term repo operation and targeted long term repo operation, wherein the RBI injected liquidity at 4 per cent for periods varying from one year to three years, the transmission to lending rate has been somewhat encouraging.

In the above context there are two critical issues: the liquidity injection has led to monetisation; and even though the bank lending rate has been in a lower territory, credit offtake has not picked off — rather, non-food credit growth declined by 1.9 per cent during the current fiscal so far (according to data released by RBI in its August 2020 bulletin).

There is a misconception about monetised deficit and monetisation. The liquidity injected by the RBI is financed by printing money, and in exchange, the collateral received by the RBI are mainly government bonds. This swells the RBI holding of government securities in its portfolio and thus printing money leads to monetisation. Monetised deficit, on the other hand, is the direct financing of the government’s deficit. This is prohibited now. It is of interest to note the monetisation impact – the RBI purchases the government securities from the monetary system in exchange for cash and receives interest income periodically; in the end net interest income (RBI income minus RBI expenditure) is transferred to the government as dividend. In theoretical literature, this is called (and is no different from) seigniorage.

A critical issue in the context of economic growth revival stems from savings and investment. In an operational sense, growth is a function of investment limited by savings. According to data released by the RBI in its Annual Report, gross financial savings (representing household assets) marginally improved relative to the GNDI (gross national disposable income) — 10.5 per cent in 2019-20 as against 10.4 per cent in 2018-19. Net financial savings as a proportion of the GNDI at 7.6 per cent showed an improvement in 2019-20 over the previous year because financial liabilities relative to the GNDI were lower at 2.9 per cent in 2019-20 from 4.0 per cent in 2018-19. This could be on account of a slide in household debt.

Strain on consumption

What will the future look like? Will the recovery be V-shaped as projected by the IMF in its June 2020 outlook? In this context, it is important to note that the RBI and government are silent about the possible future path that will unfold. However, in the annual report recently released, the RBI opined that the revival of economic growth is critically related to the lockdown. In the event the lockdown continues, the decline in consumption due to non-availability of non-essential items and the fall in income due to production retrenchment will lead to severe contraction in overall consumption, and to that extent, there will be fall in the output gap (actual output minus potential output) by minus 12 per cent of potential output. This means that the actual economic growth will continue to be in a negative territory for the full year, an indication of which is mentioned above by a contraction of 23.9 per cent in Q1.

The Covid-19 pandemic is showing signs of becoming endemic. There is no sign of respite from the infection even though the recovery rate has improved and the death rate has come down. Currently, there is a geographical U-turn in India. States which were not much affected earlier now are severely impacted. This development makes a case for the lockdown, which is an impediment to production. Thus, there are strong possibilities that the pandemic will continue for some more time (at least till we get the vaccine).

This uncertainty and the risk of a severe health disaster will jeopardise the traditional demand management stimulus interventions, and in our considered view, the pandemic-triggered economic crisis will be in all possibility be ‘U’-shaped. In the short term, collective and concerted efforts should be focussed on the health sector and on getting a viable vaccine; in the medium term, the supply management efforts should be geared up to enhance productivity, and improve the value and supply chains.

Through The Billion Press. The writer is a former central banker and a faculty member at SPJIMR. Views are personal