Pre-pandemic background –
India in 2019 was amongst the fastest growing major economies.
- GDP Growth rate – Highest growth rate among major economies in 2018-19 slightly above 7%.
- Inflation – Inflation was aggressively brought under control from 2013 levels of around 10% to within 4% by 2019.
- GDP per capita – Doubled from 2009 to 2019.
- Unemployment – Has been hovering between 5-5.5% since 2000.
- Distribution of the workforce across economic sectors –
- Agriculture ~ 42% (down from 52% in 2009)
- Industry ~ 25% (up from 21% in 2009)
- Services ~ 32% (up from 26% in 2009)
- Trade – 45% of GDP with a deficit of ~2.5% (improvement from 6.7% in 2012)
- Fiscal deficit – 3.8%
- Interest rate (repo rate) ~ 6.5%
- Inequality – Gini index hovering around 35% since 2010
While India was the fastest growing major economy in 2019, as compared to previous 6-7 years of high growth, there was a relative slow down even before the pandemic set in. This could be attributed to –
- low private consumption over a few quarters possibly owing to low farm incomes (low food prices). Private consumption forms 60% of the total economy’s GDP.
- rationalization of monetary policies in advanced economies
Interestingly, even though the elasticity of consumption has remained very high, its composition has changed in the past few years. From food & beverages, transport & communication, which are more of necessities, the spending has been shifting towards clothing & footwear, health & education, housing & maintenance. This shows an increase in discretionary spending by the households as compared to the necessities. This shift is also visible in the change in pattern of spending from consumption of goods to services. There has been a decline in share of goods in total final consumption, which has correspondingly increased the share of services by more than 1 percentage point.
Available policy options –
India is not in a currency union and has a central bank in the Reserve Bank of India.
Under the Reserve Bank of India, Act,1934 (RBI Act,1934) (as amended in 2016), RBI is entrusted with the responsibility of conducting monetary policy in India with the primary objective of maintaining price stability while keeping in mind the objective of growth.
Monetary policy framework –
The Central Government, in consultation with the RBI, determines the inflation target in terms of the Consumer Price Index (CPI), once in five years and notifies it in the Official Gazette.
The operating framework of monetary policy aims at aligning the operating target – the weighted average call rate (WACR) – with the policy repo rate through proactive liquidity management to facilitate transmission of repo rate changes through the entire financial system, which, in turn, influences aggregate demand – a key determinant of inflation and growth.
Instruments used include repo rates, reverse repo rates, open market operations, forex swaps etc.
Fiscal policy instruments –
The Fiscal Responsibility and Budget Management Act, 2003 was enacted with a view to provide a legislative framework for reduction of deficit and thereby debt, of the Central Government to a sustainable level over a medium term so as to ensure inter-generational equity in fiscal management and long term macro-economic stability. Fiscal Deficit is the only operational target for fiscal consolidation.
The central government has the ability to leverage both tax breaks and government spending. Given the financial inclusion schemes like Jan Dhan Yojana (bank accounts for all), demonitization and building the Unified Payment Interface, India has now got a very robust infrastructure in place for direct transfers.
Covid-19 response –
India has a very large informal sector employed workforce, burgeoning services and industry sectors. The pandemic and the following significant reduction in economic activity for a year, posed a very large challenge for the RBI and Indian government. In face of that, both monetary and fiscal measures were employed to initially address the immediate needs of the vulnerable households and then reviving economic activity. Financial markets experienced pressure from extreme volatility in equity markets and currency pressure from capital outflows from EMEs.
Monetary policy –
- foreign exchange swaps. 1 The Indian rupee (INR) depreciated to its lowest level of INR 76.81 per USD in early 2020. But, this decline was modest in comparison with many emerging market peers
- multipronged approach announcing liquidity augmenting measures totalling INR 12.8 trillion (6.3% of nominal GDP). The measures included long-term repo operations, open market operations to buy Government of India securities, a one-time reduction in the cash reserve ratio of banks and widening of the monetary policy corridor
- RBI attempted to provide countercyclical support to growth by reducing the policy rate by a cumulative 115 basis points since the outbreak of the pandemic. The cumulative rate reduction – taking into account the previous policy rate cuts since February 2019 – has been 250 basis points.
- Accommodative stance on inflation for some period with a long term aim to reduce the inflation to targeted 4%
- the RBI conducted outright open market operations (OMOs) and “Operation Twist” operations (special OMOs) to manage the government borrowing programme in an orderly manner.
- RBI increased the limits for temporary Ways and Means Advances (WMAs) – a short-term credit facility – available for up to three months for state governments.
- targeted sector-specific policies have been initiated to maintain flow of funds and provide support to key sectors.
- RBI has also provided relief to the vulnerable small enterprises by allowing lending institutions to restructure their debt
Fiscal policy –
Owing to a relatively small tax base, low tax to GDP ratio, it was prudent to rely more on government spending as the primary fiscal policy. The new robust infrastructure for direct transfers through digital means made it more efficient.
- government provided fiscal assistance to poor and vulnerable households in cash and in kind during the initial stages and later broadened this coverage to various sectors of the economy.
- The initial measures in April 2020 included cash transfers to poor households, distribution of free food grains and medical insurance to health workers.
- More comprehensive measures were announced under the various tranches of the Atmanirbhar Bharat package in May and November 2020.
- Policies were announced to aid the micro, small and medium enterprise (MSME) sector by increasing the coverage, providing collateral-free loans, a corpus to fund equity etc.
- Several schemes were announced to provide support to farmers and promote production of high value primary products.
- Reforms in the energy sector and labour regulations were also announced with a view to promoting investment and productivity across the manufacturing sector.
- Later rounds of fiscal stimulus focused on measures to increase capital expenditure.
The pandemic caused the Central Government to raise the level of Fiscal Deficit to 9.2 per cent of GDP in FY 2020-21 as against 3.5 per cent of GDP estimated for BE 2020-21. Since then, the Central Government has been abiding by the principle of gradual fiscal consolidation to reach at the desired level. Presently the deficit would be around 6.4%.
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