Boosting demand key for economic revival

What will be the Covid-19 pandemic’s impact on India? The Reserve Bank of India expects the Indian economy to contract in the current fiscal year. But given the recent release of GDP numbers for the quarter ending March 2020, a big-picture analysis may be needed. In a three-part data journalism series, HT attempts to do exactly that. The first part, which appeared in the edition dated June 6, looked at the economic situation before the pandemic. The second part, which appeared yesterday, looked at the immediate effects of the crisis and their macroeconomic consequences. The third part will argue that the existing policy response might not be enough.

On 12 May, in an address to the nation, Prime Minister Narendra Modi announced an economic package worth 10% of India’s GDP. Finance minister Nirmala Sitharaman announced the details of the package in press conferences over the next five days. The package does amount to over ₹20 lakh crore. But the actual fiscal spending involved is much lower. In fact, two-thirds of the package is focused on credit infusion programmes. These include guarantees by the government and provision of additional liquidity by the Reserve Bank of India. The package also announced major steps to deregulate agriculture markets.

The lack of fiscal push surprised not just commentators but even markets. A research note by Pranjul Bhandari, Chief India economist at HSBC Securities and Capital Markets says that “while markets were expecting a more demand-side stimulus...a large part of the attention has been towards medium-term supply side measures”.

What should be the objective of an economic package during this pandemic? It depends on the economic situation before the pandemic. If the economy was in good shape, it should focus on restoring the status quo. However this is not the case with India. As pointed out in the first part of this series, the Indian economy was caught in one of its worst ever deceleration phases before the pandemic. So, just getting the economy to where it was immediately before the pandemic, difficult as it is, is not going to be enough.

Part I of this series argued that India was facing a demand driven slowdown before the pandemic. Part II argued how loss of incomes due to reverse migration could squeeze rural incomes and demand. So, supply side measures such as easing credit supply are unlikely to help boost the economy, although some businesses may benefit from it.

As for the emphasis on reforms, a key component of the package that was announced, not all of these will increase demand. Reforms generally improve the ease of doing business, and thus make an economy more attractive for investment.

The failure of corporate taxes reforms announced last year to boost investment activity is a classic example of how something aimed at improving the business environment may not result in sustained demand.

Where does demand come from? In a modern economy, it comes from three sources: domestic consumption, exports and investment. Imports represent negative demand, as local purchasing power is diverted towards foreign goods. India enjoyed a good export growth phase until the 2008 financial crisis. The performance has been disappointing post-2008. With the multilateral trading regime in jeopardy, rise of protectionism and trade wars and shock of the pandemic, exports are unlikely to revive anytime soon. Another factor which will prevent an export surge is India’s inability to join any major mega regional trade treaty. The inability of exports to boost growth like they did in the pre-2008 period is a structural shock to the Indian economy.

This leaves domestic consumption. Private Final Consumption Expenditure has had a share of almost 60% of India’s GDP in the recent period. India’s private spending is very unequal in nature. An analysis of 2011-12 NSSO data (latest available figures) shows that almost half of it came from the top 20% of the population.

The NSSO numbers probably underestimate India’s income inequality. An analysis of income tax data shows that 90% of income taxes in India came from the top 5% of the 50 million who even file income tax returns. India’s workforce is more than 400 million strong.

So, what can be done to boost consumption demand? The consumption of the rich could actually go down rather than increase. A Mint column by Niranjan Rajadyaksha explained why this could happen due to the pandemic’s economic pain. “Precautionary savings tend to rise under conditions of income uncertainty. People who have lived through a storm understand the importance of setting some money aside for rainy days”, the column said. “There is thus a strong likelihood that the income uncertainty people are experiencing right now will nudge Indian households to increase precautionary savings at least for the next few years. And this psychological switch may persist even after the Indian economy recovers momentum” it adds. Given the fact that India’s private consumption is skewed towards the rich, any cutback in consumption demand will make economic revival even more difficult. As the column argues, easier credit provisioning might not help in this case.

This leaves investment as a driver of growth. Demand for capital goods is a derived demand. Unless businesses see future growth in domestic demand or exports, they will not invest. This is exactly what has been happening in India.

What does this entail for Indian economy’s prospects? The concept of paradox of thrift developed by John Maynard Keynes, is important here. It says that if everybody were to start saving more in an economy, aggregate demand would go down. This will lead to lower incomes. Because savings are a fraction of income, collective savings will go down as well.

So what should be done? A democratically elected government cannot force individuals to make consumption or saving decisions. However, there is merit in focusing on the bottom 80% of the population. A large part of this struggles to make ends meet. It can hardly save if even if it wants to. NSSO data shows that at least half of India’s population spent half of its budget on food. This is in keeping with the 40% weight of food in India’s retail inflation basket. The primacy of food in household budgets is also the biggest political economy fault line in India. A rise in food prices hurts the poor. A squeeze hurts farmers. Governments juggle this balance.

However, this need not be a zero sum game. An expansion of the current food security programme could benefit both farmers and consumers. One such way could be allowing employment of MGNREGS workers in private agricultural activity. This can be rolled out almost immediately. The paddy cultivation season will start in weeks.

Another area where things can be changed in the medium to long term is health and education services. In India, even the poor spend beyond their means on private education and healthcare. An improvement and expansion in public services could change this trend.

Investment in food security, health, education etc. is generally seen as a resource diversion from physical infrastructure which directly promotes growth. There might have been some merit in this argument in India as long as the consuming classes consume. In the absence of any incentive to – the package announced by the government has little by way of putting more money in the hands of people – this is a perverse argument. State spending in the food economy and social sector, even with stagnant or slightly lower wages, could free up a greater amount for spending by the poor in the non-farm economy. It could just be an extra pair of slippers or a bicycle.

This series draws from the author’s work at the Centre for Advanced Studies of India at University of Pennsylvania as a visiting fellow. It is in the process of being developed as a working paper.