What does the future hold for the Indian economy, which is most likely to contract in 2020-21? The six-member monetary policy committee (MPC) of the Reserve Bank of India (RBI) deliberated over the likely economic scenarios in the first week of August to set the policy rates. There is, however, a lot of uncertainty over the economic recovery because of rising COVID-19 infection, business disruption and the result of existing stimulus measures.
"The outlook is grim; even when it improves, the expectation is one of slow, hesitant recovery, with the situation likely to worsen before it gets better," said Michael Debabrata Patra, Deputy Governor in charge of monetary policy at the RBI. Given the high inflation numbers and the apprehensions about the negative GDP growth both in real and nominal terms, Ravindra H. Dholakia, former Professor, Indian Institute of Management, Ahmedabad was blunter. "This would imply that the economy is not caught up in recession with deflation but in a deep stagflation, which occurs when the adverse supply shock is more severe than the demand shock," he said. The supply side disruptions have the potential to fuel inflation. In addition, a large liquidity stimulus will have its own consequences in increasing the money supply in the economy. To top it, the global liquidity is also expected to flow into emerging markets like India.
Dholakia had advised that under such circumstances, expansionary aggregate demand policies - both monetary and fiscal - would result first in fueling inflation rather than in increasing output and employment expansion and growth recovery, which is expected under recession with deflation.
There were also suggestions for revival. "A durable revival of the economy depends on sustained policy support to resuscitate activity in various sectors, restore employment and livelihood to the displaced and dispossessed, continue to assure health support and pursuit of the vaccine, ease financial stresses facing households, businesses and financial intermediaries, instil confidence and anchor financial stability before it slips away," advised RBI's Patra. This long list includes a close coordination between the Centre and states to contain the health crisis. The daily COVID-19 cases have already touched 70,000 with the total cases reaching 28 lakh-plus. Things like restoring employment and livelihood especially for migrants and factory workers require huge stimulus support to the industry, especially to the construction, real estate , infrastructure and manufacturing sectors.
Chetan Ghate, Professor, Indian Statistical Institute suggested that the major brunt of future fiscal stimuli should be tilted towards social insurance payments and on the taxation side, where the multipliers are larger. "It is important to recognise that fiscal multipliers depend on country characteristics. They are smaller in countries with flexible exchange rate regimes, open to trade, and with high levels of public debt. India has all three," he said.
Ghate explained that fiscal multipliers may be larger at the zero-lower bound, but India is not there yet. Prices are also more flexible in developing countries like India because of the presence of a large informal sector. This weakens the transmission of fiscal policy from financial markets to the real economy. "Fiscal stimulus design will have to keep these factors in mind, and will have a strong bearing on the type of cyclical recovery that the economy experiences. Economic policy is a potent tool for equilibrium selection at the current juncture," said Ghate.