Raghuram Rajan on Indian economy: Stimulus is the tonic needed for the patient on sickbed

Likening the economy to a patient, former Reserve Bank of India Governor Raghuram Rajan said that government relief is the “sustenance the patient needs while on the sickbed.”

In a LinkedIn blog titled ‘The Alarm in the GDP Numbers’ posted on September 7, Rajan cautioned that India’s dismal Q1FY21 GDP numbers “should alarm us all”, adding that the 23.9 percent contraction would “probably be worse” if informal sector estimates are included.

Rajan noted that in the current economic environment, government-provided relief “becomes all the more important”, but criticised the announcements so far as “meagre and patchy”.

“This has been meagre; primarily free food grains to poor households; and credit guarantees to banks for lending to small and medium (SMEs) firms, where the take down has been patchy,” he said, adding that the government’s strategy to conserve resources for a possible future stimulus is “self-defeating”.

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Comparing the economy to a patient, Rajan said: “…relief is the sustenance the patient needs while on the sickbed and fighting the disease. Without relief, households skip meals, pull their children out of school and send them to work or beg, pledge their gold to borrow, let EMIs and rent arrears pile up... Similarly, without relief, small and medium firms - think of a small restaurant - stop paying workers, let debt pile up, or close permanently. Essentially, the patient atrophies, so by the time the disease is contained, the patient has become a shell of herself.”

He then said that economic stimulus can be thought of as the tonic. “When the disease is vanquished, it can help the patient get out of her sickbed faster. But if the patient has atrophied, stimulus will have little effect.”

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“Even if they start earning, indebted households will not consume freely, especially if they believe they have to manage further periods without livelihoods or government help. Similarly, even small and medium firms that have stayed open but have huge unpaid bills and interest will not be able to function well,” he pointed out.

“Without relief measures, the growth potential of the economy will be seriously damaged. Brazil, which has spent tremendously on relief, is seeing a much lower downgrade to medium term growth than India,” he added.

Rajan further criticised government officials for holding out on possible stimulus for when India finally contains the virus, and said they are “underestimating the damage from a more shrunken and scarred economy at that point.”

“Instead of claiming there is a V-shaped recovery round the corner, they should wonder why the United States, despite spending over 20 percent of GDP in fiscal and credit relief measures, is still worried the economy will not return to pre-pandemic GDP levels by the end of 2021,” he added.