Recovery May Be Staggered

The prognosis for recovery from the economic fallout of Covid-19 in India is yet to reach any consensus among observers. The view so far dominant seems to favour a cautious but optimistic V-shaped trajectory in recovery. The GDP growth in real terms is predicted to be 10.1 per cent in 2021-22, as per the Monetary Policy Report of the RBI, released in October. The World Economic Outlook of the IMF, published in the same month, forecast an eight per cent growth in India's GDP for 2021-22.

With an estimated contraction of 9.5-10 per cent in GDP in the current fiscal year, 2021-22 is most likely to end with a level of real GDP, at least two to three per cent below that of 2019- 20. In other words, we have to wait till 2022- 23 to see the return of the pre-Covid real GDP. However, as the quip goes, making predictions is a rather hazardous job, especially about the future.

What is less emphasised in the discussions that followed is the continuing hold on the economy of the problem of deficient demand. The problem is indirectly reflected in the household savings data. In the first two quarters of this year household savings as a percentage of GDP have been much higher than the usual. The data released by RBI in November show that India's household financial savings constituted 21.4 per cent of the GDP in the April-June quarter - a sharp increase from 7.9 per cent in the same quarter of the previous year.

A small increase in the quantum of savings combined with a sharp contraction in GDP raised the share of household savings in GDP. The growth in bank deposits far exceeded the growth in advances. Ironically, this has happened in spite of sharp deteriorations in the known determinants of household financial savings, i.e. income and interest rate.

The rise in savings may be attributed to the pandemic-induced reduction in discretionary spending as well as a surge in precautionary savings. In the absence of a comprehensive net of social security to protect households against contingent risks, households tend to cut down spending on consumption and save more to tide over future contingencies. Households in aggregate, therefore, are not spending enough to give the necessary push to aggregate demand. This is a clear sign that the recovery would be more staggered than what has been predicted. As a matter fact, the RBI Bulletin itself has noted that "the trend of higher-than-usual household financial savings can persist for some time till the pandemic recedes and consumption levels get normalised."

Ironically, the important recent legislations, such as the new labour codes and the farm laws, which have been hastily passed without debate and discussions in Parliament, address the socalled need for reforms on the supply side, when the problem seems to be as severe on the demand side, if not more. Generally, the extent of contraction that the countries have experienced has a significant connection with the size of the direct fiscal stimulus pursued in the respective countries. For example, both the US and Brazil went for extensive direct fiscal stimulus that amounted to roughly 10-12 per cent of GDP, whereas India's fiscal stimulus constituted only around two per cent of GDP. This measly sum would hardly be able to pull the economy out of the slump, no matter how optimistic the prognoses may sound at the moment.

An elementary lesson from macroeconomics is that when aggregate demand is low, indirect measures like lowering interest rates or credit guarantees do not work. Direct transfers to the poor and the jobless in various forms could serve the twin objectives of raising the lot of the poor and at the same time boosting the demand necessary for stimulating the economy.