Economic recovery: Challenges & way forward

ECONOMY/ GOVERNANCE

Topic: General Studies 2,3:

• Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment. 
• Government policies and interventions for development in various sectors and issues arising out of their design and implementation

Economic recovery: Challenges & way forward

Context: The COVID-19 pandemic has brought global economic activity to a virtual halt an induced recession.

Did You Know?

• The IMF estimates the global economy to contract by -4.9 per cent in 2020
• With regards to Indian economy, growth has been decelerating for the past eight quarters, and indications by the RBI suggest that growth is contracting for the first time in four decades. 

What has been the economic scenario of India in recent years?

• Consumption and investment demand in India have been subdued for the past few quarters, dragging down overall growth.
• These two components were perhaps casualties of a sharp deceleration in credit supply even after an impressive bank cleanup exercise by the government and RBI. 
• The IL&FS debacle in September 2018 only made matters worse. 
• The NBFC sector, which played an important role in fuelling India’s consumption growth, suffered from funding crunches leading to a further squeeze in credit supply, thereby impacting consumption demand. 
• This deceleration was exacerbated in the wake of pandemic & lockdown

Has government taken steps to tackle the economic crisis?

Yes, government has taken steps like 

• Economic package – PMGKY – for addressing the short term needs of society particularly weaker sections of society
• RBI actions to provide much-needed near-term liquidity support 
• Long-pending structural reforms (Ex: Agriculture, Coal, Textile) aiming towards medium-to-long-term stability

However, government needs to further aid a demand recovery

What Keynesian Theory says about demand recovery?

• Keynesian theory suggests that for aggregate demand to increase, at least one of the components of GDP needs to expand. 
• Growth in the Indian economy has been dominated by 
  • Consumption (PFCE)
  • Investments (GFCF) 
  • Government expenditure (GFCE) 
  • Net exports (NEX). 

Challenges with reviving economy

1. Challenges with increasing Investments: 

• Uncertain economic prospects restrict bankers to lend further despite measures taken by government & RBI. A higher rate of investments is essential for sustainable economic growth. 
• Increasing levels of debt during this deteriorating economic scenario along with rating downgrades for industries are likely to aggravate existing problems.

2. Challenges with increasing Consumption:

• Industry-wide job/pay-cuts with a growing sense of uncertainty over the future may limit spending to non-discretionary items and force people towards precautionary savings.
• Estimates suggest that PFCE will grow at its slowest pace in 15 years.

3. Challenges with increasing exports

• Disrupted global trade due to heightened trade tensions between the US and China, especially in the wake of pandemic. 
• Global trade witnessed its steepest decline since 2009, falling by -4.3 per cent in March over the previous year, with only downside risks from hereon.
• India’s limited share in global trade along with a battered domestic and global outlook provides little room for exports to contribute towards growth.

Solution to revive economy 

• With the above challenges we can see that government expenditure is the only exogenously determined element in a Keynesian framework. 
• The positive push required to aid a demand recovery has to come through increased government expenditure
• However, given the sparse resources that India has, government must deploy funds that yield a higher return. 
• One key area that can provide the necessary support is infrastructure investment. 
• Historically, countries have used infrastructure to provide counter-cyclical support to the economy – New Deal in the US, Germany’s expansion post-WWII debt reduction (1953) and more recently with China in the wake of the Global Financial Crisis. 
• Infrastructure has strong links to growth and with both supply and demand-side features that help generate employment and long-term assets
• 1 per cent of GDP spend on infrastructure can boost real growth by 2 per cent while creating 1.3 million direct jobs
• Front-loading key projects with greater visibility from the recently announced National Infrastructure Pipeline (NIP) could aid in a quicker recovery.

Way Forward

• India already has several institutions for infrastructure development purposes from the likes of IIFCL, IRFC to more recently NIIF
• However, over these years, their scale and functioning have remained inadequate. A relook, to restructure these into one large development institution could help reduce inefficiencies and allow for greater leverage
• Taking a cue from China, floating special infrastructure bonds through this organisation to accelerate the funding of the NIP could aid a speedier recovery.
• Development of state government and urban local body bond markets by leveraging the capabilities of this large development institution

Connecting the dots:

• FRBM Act
• 2008 Financial Crisis