Steering India’s Economy post-COVID ‘Shock’ – Areas of Concern for Policy Makers

 ‘India under a 21 days lockdown’ stated the newspapers on March 22nd earlier this year. Ever since, to prevent the spread of the COVID-19, the Indian government along with the states had imposed a strict lockdown by using its powers under National Disaster Management Act and the Epidemic Diseases Act, 1897. 

Owing to the strict lock-down measures across the country there were restricted movements (except for essentials). This meant the transport business was majorly impacted across the board. Be it the airline industry, the Indian Railways, or the roadways. Along came the issues of health infrastructure at the local level. Battered by the unavailability of an adequate number of beds at hospitals, the number of physicians per 1000 population, the short supply of medicines. Accompanied by the lack of access to universal health coverage, exorbitant rates of treatment in private hospitals, and low public investment in health (as a percentage of the Gross Domestic Product (GDP). India ranked 57  in the Global Health Security Index which measures a country’s preparedness following pandemics. The USA is ranked at number one and most other European countries are relatively much better off. 

All this indicates that it was high time India went for a total revamp of the public health system and made it more accessible and affordable. Thus in terms of a real ‘shock’ – demonetization of Indian currency notes and the Goods and Services Tax  (GST) reforms were referred to as the major disruptions affecting the economy. Following the poor state of the economy, the COVID-19 pandemic exacerbated the situation by bringing most of the economic activities to a standstill.  

Macro-picture amidst a Black Swan event

In light of the above issue, it is essential to look at data available and diagnose the problem areas that need immediate attention. Given the complexity of the Indian economy, it would be a while before one would actually see GDP on the rising side of what has been touted as ‘V’ shaped recovery. Recent data published by the Ministry of Statistics and Programme Implementation (MOSPI) showed a maximum drop in the quarterly growth of the economy–  a whopping minus 23.9%. There has been considerable debate on a few indicators like GDP growth, bank credit growth, Non-Performing Assets (NPAs) in popular media but critical things get lost in the discussion with misplaced priorities. This piece is an attempt to highlight those which get side-lined and re-emphasize their importance in the overall economic set-up.

Before getting into the specifics, I would be tempted to call this the real ‘shock’; treatment (not of our own making) in comparison to De-Mo and GST as in the latter’s case, economic activities did not shut down. 

The pandemic hit economy cannot be compared to wartime because even then one would expect economic activity to pick up owing to an uptick in domestic defense spending. In short, to quote Nassim Nicholas Taleb, it’s yet another Black Swan event. As the COVID-19 infections spread at an alarming rate, for policymakers and economists will no doubt achieve a consensus on the axiom: life must go on.

Structural problems persist despite agriculture productivity

At the outset, while GDP has shrunk by 23.9 % (relative to Q1 figures of 2019), the Gross Value Added  (GVA) figures put the decline at – 22.8 %.  GVA is the supply side of the economy while GDP indicates the demand side of the economy. The only positive growth has been recorded in a sector which has been the mainstay of our economy for many years – agriculture. Its growth in Q1 of 2020 has been pegged at 3.4 % indicating that it has cushioned us against further decline. Shout out to our farmers who toiled in the scorching heat, despite COVID to ensure meals on everyone’s table. This should be a wake-up call for economists and analysts to understand the role of agriculture in the growth matrix. It’s in dire need of indirect support through better irrigation systems and power. Accompanied by better market access and freeing farmers from the middlemen and encouraging them to take up crop rotation (growing more than one crop per season). This would help the Indian agricultural sector realize its true potential and improve its annual growth. 

Before we go further onto what is the key ailment in the economy, we have to take a look at the state of consumer demand which is a major driver of growth at the local level.

Delving into an understanding of consumer demand– a key indicator or rather a high-frequency indicator of consumer demand is the sale of commercial vehicles (cars, motorbikes, etc.). There is a drop by nearly 85 % in Q2, (relative to Q2 of 2019). The plunge in sales is a big indicator of how much consumption has been affected by the shock. The construction industry and real estate figures show that there has been a drop in sales by nearly 79% y-o-y with inventory overhang at 35 months (implies it can take so many months to clear/ sell the plots lying idle). Cement production has come down by 36 % with almost no demand from the construction and housing sector.

The low demand has caused a massive crunch by reducing the business prospects for affordable housing. What one, however, needs to realize is that these were declining at a relatively slower rate before the shock and only aggravated on account of the strict lockdown measures. 

In short, the problem is lack of demand!

When it comes to the two other major sectors – manufacturing and services, we find that the former is down by 39 % in Q1. A major component of the services sector – construction and trade and hotels are down by 50 % and 47 % respectively. These are the ones that largely employ substantial semi-skilled migrant laborers. Thus, the lockdown has reduced their incomes through a negative multiplier effect and consequently affected the already lagging aggregate demand. 

If one were to now look at the major GDP components to make a final analysis, Private final consumption expenditure (PFCE) has declined by 2 % from last year but has retained a major share while government expenditure is still at 18%. What should worry policymakers is the contraction in PFCE coupled with a 10 % decline in Gross Fixed Capital Formation (GFCF)  or investments. The demand for loans remains sluggish as RBI maintains an accommodative stance and banks reduce the rate on Fixed Deposits that have led to a reduction in gross savings. 

Trickle Down doesn’t work – Time for Bottom-Up policies

Such a ‘shock’ treatment ought to have made policymakers realize that the key aliment in the economy was declining aggregate demand. An abysmal economic situation which only took a turn for the worse owing to the performance of the aforementioned indicators. 

Policies driven to revive the demand at the micro level seems to be the short-run solution that would boost the economy reeling under the pandemic shock. Economists advocate for ease of doing business but it is usually addressed to corporates and the industrial sector. It is time to do away with unnecessary local level regulations like the Shops and Establishments Act (at least for a limited period of 2 years) and related municipal rules for quality control. The credit channel has to bolster small businesses to receive loans and cushion the organized business sector. At a macro level, policymakers should also consider doing away with payments of GST for a year (after fixing a threshold limit for the turnovers) to enable local manufacturers and small businesses to retain adequate working capital. This could be invested in kickstarting a cycle by employing more labor from their areas.

Since the moratorium on interest payments is already being considered, the above proposals would add to the overall aim of resuming production in a big way at the state level. There is a need to boost infrastructure spending (completing projects within a fixed time frame) through private partnership at the city-level (wherever possible) and giving a tax-holiday to small businesses and the middle class to spend adequately and raise the aggregate demand.

The rationale for such radical moves as stated above arises from the fact all these regulations dis-incentivize businesses (from a small kirana shop to a major departmental store to a factory). Compliances increase the cost of running the business amidst a sharp drop in the markets and discourage small and medium businesses to continue. 

At the time of the pandemic, the demand side has to be prioritized i.e we have to adopt a bottom-up approach as opposed to the erstwhile ‘command’ logic which meant a top-down approach. It is therefore unsound to assume that growth would ‘trickle down’ after a lag period. As time goes by, the areas of concern as brought out here have to be closely monitored by researchers and policymakers alike as they hold key to reviving demand and go on to revive growth at least by the year-end if not later.

Time is thus ripe for a set of radical reforms akin to 1991 but it should be more broad-based to enable faster growth at the local levels.

Key takeaways 

  • India’s economic growth has been declining much before the pandemic hit us and COVID has only worsened the situation by total disruption.
  • Health infrastructure needs a total to revamp to avoid similar situations in the future and this calls for a massive public investment in the health sector. 
  • Key sectors like construction, trade, and services have shown a very serious decline over the last few months and as a consequence, indirect employment generation has been affected leading to a sharp fall in consumption levels. 
  • This has created a significant reduction in the aggregate demand and thus it is the demand side of the economy that needs immediate attention. 
  • It is time for reducing the government’s space in the economy to enable growth by private players at the local level. This can only be enabled by de-regulation at local levels that constrain production and employment.
  • Incentivize small business units to borrow at nominal rates of interest and employ labor adequately and thus increase purchasing power and as a consequence raise demand.

Further readings : 

‘RESET’ by Dr Subramanian Swamy, MP Rajya Sabha (Rupa Publications)

‘India Un-Inc’ by Prof R Vaidyanathan (Westland Publications) (Discussion on Reviving Indian Economy) 

Pavan Thimmavajjala
Pavan is currently pursuing Masters in Economics from the University of Hyderabad. His research interests include growth economics, macroeconomics, and law. He is also a blogger and runs a podcase titled 'Seedhi Baat'.