The dangers of misplaced optimism
Paper:
Mains: G.S. III Indian Economy
Context
- Preliminary evidence that India’s economy contacted by 7.5% in the second quarter of financial year 2020-21 was, both good and bad.
- Good because that figure is far lower than the 23.9% contraction registered in the first quarter of this financial year.
- Bad because a 7.5% second quarter contraction is high both in itself and when compared with most similarly placed countries. The figure signals that the substantial relaxation of lockdown restrictions during that quarter has not ensured automatic recovery.
Explanation
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- The government sticks with it recovery hype. It has chosen to focus on the unsurprising evidence that GDP rose sharply, by 23% between the first quarter and the second .
- Based on this evidence, the finance ministry’s monthly economic report for November, speaks of a V-shaped recovery reflective of the resilience and robustness of the economy.
- The danger is that such optimism would provide the justification to avoid adoption of the measures crucially needed to pull the economy out of recession.
- Lockdowns limit production and result in a rundown of inventories. They also adversely affect employment, income and demand.
- When lockdowns are relaxed, there shall be rise in production, not just to meet demands backed by the available purchasing power but also to restore inventories to normal levels across the distribution chain.
- Once the inventories are restored, demand must return to and rise above pre-crisis levels for production to recover and grow.
- With the lockdown-induced adverse effects on demand of the loss of jobs and livelihoods, the increased indebtedness and bankruptcies precipitated by the crisis bound to be felt well after the restrictions are relaxed, the task of providing safety nets, reviving employment and spurring demand become crucial.
- The market cannot deliver on these fronts, state action facilitated by substantially enhanced expenditure is crucial.
- Since government revenues shrink during a recession, that expenditure has to be funded by borrowing. This is no time for fiscal conservatism.
- The very little and small evidence on GDP movements must be read, with the caveat that these are preliminary estimates based on the limited information.
- There are number of features underlying aggregate performance that are suggestive of the dynamic of the post-COVID 19 economy.
- The decline in private final consumption expenditure at constant prices , which accounts for 56% of GDP, has come down from minus 27% in the first quarter to minus 11% in the second, it still remains high. Though there are signs of a short-run recovery in private consumption demand with the lifting of lockdowns, net incomes and consumer confidence are not at levels that can even restore last year’s levels.
- With production restraints relaxed, depleted stocks are being replenished. The direction of changes in stock levels has reversed, with a call of 21% in first quarter turning into an increase in stocking of 6.3% in the second quarter.
- However, these signals from the demand side have not been adequate to spur an investment revival.
- The decline in fixed capital formation has fallen from a high minus 47% in the first quarter to minus 7% in the second, investment is still falling year-on-year.
- These are all signs of an economy that is severely demand constrained, requiting a significant step up in government expenditure.
- However, the government has not just chosen to hold back on its own spending but is adopting a stance that would squeeze expenditure at the state level as well. To start at the central level, figures from the Office of Controller General of Accounts relating to the first seven months of 2020-21 (April to October) indicate that, over this crucial period, the total expenditure of the central government stood at 55% of what was provided for the budget for 2020-21, which too was woefully inadequate even for normal times. In fact, in a non-COVID 19 year, 2019-20, the ratio of actual spending by the central government over April-October relative to that budgeted figure was a higher 59%.
- The shortfall in spending was sharper in case of capital expenditure, with 48% of that budgeted being spent over April to October. The corresponding figure for 2019-20 was 60%.
- With GST revenues having fallen from their lower than expected levels during the COVID-19 months, the states have been cash-strapped. Yet the government has decided not to compensate them for the shortfall, as promised under the GST regime. States gave been left to fend for themselves by going to market and borrowing at high interest rates.
- The net result of this voluntary and enforced fiscal conservatism in the middle of a pandemic, which calls for hugely enhanced spending, is visible in the GDP figures. Government final consumption expenditure, which rose by 10% in the first half of 2019-20, declined by 4% in the first half of 2020-21, when it should have been rising.
- The rationale that underlies this privileging of fiscal conservatism over growth and welfare, is nowhere explained. But there are signs of where it possibly comes from (wealth of the super rich explode during pandemic).