Indian Economy Review | August 2020


  • Covid-19 has made growth challenges more complex, says RBI
  • No definitive growth forecast; post-pandemic recovery to be different
  • No hasty or disruptive withdrawal of regulatory easing
  • A long list of policy prescriptions for boosting the economy
  • Focus on global supply chains and free trade agreements
  • Shifting policy focus for agriculture and manufacturing
  • A four-pronged approach to address woes of the financial sector
  • GST compensation cess transfer to states comes to a halt
  • No bailout by Centre as states given two options
  • Burden on states set to rise further as their borrowing spurts
  • First-quarter stress for India Inc, industrial output and trade
  • Revenue shortfalls neutralise expenditure containment gains
  • Unemployment trajectory reveals rural-urban divide

Covid-19 has made growth challenges more complex, says RBI

 Thanks to the 2019-20 annual report of the Reserve Bank of India (RBI), released in the last week of August, there is now greater clarity on the nature and extent of the current stress in the Indian economy. The central bank has analysed the state of the Indian economy in the context of two different phases – one that obtained before the outbreak of Covid-19 and the other after the pandemic, as also the lockdown, which adversely affected economic activity. The sobering message the Annual Report conveys is that even before the onset of Covid-19, India’s growth trajectory had begun showing signs of moderation, reflecting both global and domestic cyclical forces.

Global drivers included soft external demand, fresh automobile emission norms in different countries, trade tensions and global trade policy uncertainty, the Brexit imbroglio, a slowdown in China and weak macroeconomic conditions. The domestic factors, casting their adverse influence on the Indian economy, included an inventory build-up in the real estate sector, unfavourable terms of trade affecting the rural economy, a sharp deceleration in the investment rate and a contraction in merchandise exports from the first quarter of 2019-20 and in imports from the second quarter of the same year. To complicate the problems further, there were new automobile emission and axle capacity norms, affecting demand for commercial vehicles, in particular, and financial stress building up in the non-banking financial sector. 

No definitive growth forecast; post-pandemic recovery to be different

What is the growth outlook in the current year? The RBI Annual Report makes no definitive forecasts on the growth front. Indeed, it notes that “the jury is out on a wide array of possibilities that can characterize the future.” This makes the RBI perhaps the only central bank of a major economy to have stayed away from making a forecast on the growth contraction that its economy will witness. But its prognosis is quite gloomy. The possibilities characterizing the future, according to the RBI, range from a V-shaped rebound led by a spurt in demand to a “structural stagnation brought about by behavioural and demographic changes”. 

The RBI concedes that the outlook therefore could be sombre, as India’s potential output could “undergo a structural downshift as the recovery driven by stimulus and regulatory easing gets unwound in a post-pandemic scenario”. The central bank points out that the recovery after the pandemic will be different from what was seen after the global financial crisis of 2008. The global financial crisis engulfed the economies of the world after years of strong growth with macroeconomic stability. In contrast, Covid-19 has affected the economy after many quarters of slowdown. More importantly, the global financial crisis was a financial meltdown, while Covid-19 is a health challenge affecting the real and financial sectors.

No hasty or disruptive withdrawal of regulatory easing

The RBI notes further that the government has responded to the pandemic crisis with conventional and unconventional measures to mitigate its impact on economic output. The challenge for the government, therefore, will be formidable. But the big assurance from the RBI comes with respect to what it intends to do in the post-pandemic situation. Once the pandemic is over, the stimulus has to be unwound in a calibrated and non-disruptive way. This is an assurance to India Inc and the markets that no hasty decision would be taken to unwind the regulatory relaxations and other special measures taken in the wake of Covid-19. What’s more, the RBI insists that after the pandemic, deep structural reforms in factor as well as product markets, the financial sector, the legal framework and competitiveness have to be undertaken in order to recoup the potential output losses and return the economy to a sustainable path of robust growth along with macroeconomic stability.

A long list of policy prescriptions for boosting the economy

The RBI has outlined an exhaustive list of what the government must do in the coming years to help the economy regain its earlier growth momentum. The recommendations are made on the premise that the shock of Covid-19 for consumption has been severe and any recovery will be a long haul. The RBI prescription begins with a strong plea for a targeted public investment plan, funded by monetization of assets in steel, coal, power, land, railways and privatisation of major ports under an independent regulator. The expectation is that such public investment can attract private investment in due course. The RBI also sees the need for diversifying financing options, providing alternatives to bank finances and improving the business environment through faster enforcement of contracts, speeding up property registration processes and building adequate judicial and insolvency resolution capacities. Equally important is to leverage information and communication technology to reduce transaction and communication costs, generate productivity gains with the help of low-cost supply of knowledge-based solutions within the country and abroad. Fulfilling much of this wish list depends on the government and it remains to be seen how seriously the government views the need for implementing these recommendations in the post-pandemic scenario.

Focus on global supply chains and free trade agreements

On the foreign trade front, the RBI Annual Report believes that Covid-19 has changed the environment for global value chains and this has important implications for India’s exports potential. The central bank, therefore, has suggested that instead of spreading its resources thinly and widely, the government should identify the sunrise export sectors, which can enjoy productivity gains and have dynamic linkages to help them strengthen their footholds in emerging global value chains. Contrary to what appears to be the government’s slow and tentative approach to preferential trade arrangements, the RBI prescription suggests that India should focus on exports through free and preferential trade arrangements. It could embark on such a path by completing the India-European Union free trade agreement and a post-Brexit free trade agreement with the United Kingdom and tie up special trade arrangements with countries supplying rare materials needed for new export products of greater critical importance.

Shifting policy focus for agriculture and manufacturing

The RBI has important messages for the government on agriculture and the manufacturing sector. Recognising the need to shift the terms of trade in favour of agriculture, the central bank has advocated the need for moving away from a reliance on minimum support prices as the main instrument of incentives. Since minimum support prices have been expensive, inefficient and can even cause distortions, the RBI believes that the need of the hour is to frame policies for managing the current surplus situation in Indian agriculture. The policies should be geared more towards ensuring a sustained increase in farmers’ income along with reasonable prices for consumers. This goal can be achieved by building an efficient domestic supply chain. On manufacturing, the RBI believes there is a need for a complete rethink to tackle the structural slowdown in this sector. The rethink could be aimed at enhancing the quality and efficiency of the physical infrastructure to help the manufacturing enterprises. A key area of focus should be the healthcare and tourism sectors, where India has an advantage and this should be exploited by encouraging private enterprises and increasing investments in these areas.

A four-pronged approach to address woes of the financial sector

Analysing the financial sector, the RBI had done some plain speaking by citing four critical challenges that face it. One, the banking system in India has to be freed from the current risk aversion that poses a big hurdle to the flow of credit to the productive sectors of the economy. Such risk aversion has also impaired the role of the banking system to become the chief financial intermediary in the economy. Two, the worsening of the macroeconomic and financial conditions in the economy has adversely affected the health of the banks and the recent regulatory easing may make it worse, unless the situation is closely monitored and the relaxations are used judiciously. Three, the need for recapitalising banks, the state-owned banks in particular, has become more critical in the wake of the pandemic. The RBI has already advised banks and NBFCs to carry out stress tests and take necessary corrective steps with regard to provisioning for stressed loans and capital adequacy. And four, the RBI is planning for an optimal level of regulation and supervision of NBFCs so this sector becomes financially resilient and capable of meeting the financial needs of a variety of customers, thereby providing complementarity and competition to banks.

GST compensation cess transfer to states comes to a halt

The 41st meeting of the Goods and Services Tax (GST) Council, held on August 27, attempted to end the uncertainty over compensation to states, whose revenue growth, because of the pandemic and economic slowdown, has been less than the 14 per cent mandated under the law for a period of five year till end-June 2022. The GST was introduced from July 1, 2017. The GST laws had allowed the levy of a compensation cess on a set of luxury and sin goods like tobacco, aerated water and automobiles, over and above their peak rate of 28 per cent. The cess rates varied and the amount collected under them was used to compensate the states for their revenue loss, if any. The Covid-19 pandemic and the lockdown struck a blow to the GST revenues and the states’ compensation demand during 2020-21 is estimated to be over Rs 3 lakh crore, but the compensation cess collection during the year would not exceed Rs 65,000 crore. Hence, the states are staring at the bleak prospects of the compensation amount dropping significantly. No cess compensation has been transferred to the states so far in the current financial year. This has squeezed the states’ capacity to pay their dues, with a few of them even unable to pay salaries to their staff.

No bailout by Centre as states given two options

The formula to end this uncertainty, proposed at the GST Council meeting on Thursday asks the states to choose from one of the two options. The states will have to get back to the Centre on which option they want to adopt within a week. The first option envisages that the Centre would help the states borrow Rs 97,000 crore, the shortfall amount that would arise due to the GST’s implementation. States that prefer the first option would also enjoy a relaxation in their borrowing limit by 0.5 percentage point. The second option is that the Centre would help states borrow the entire cess shortfall amount of Rs 2.35 lakh crore because of the GST implementation and the impact of Covid-19. In both the options, the Centre would help the states borrow from the Reserve Bank of India and the repayment of the borrowing would be from the collections of compensation cess to be levied beyond June 2022. This would have two major implications. One, the Centre, much against what the states had desired, would not borrow the amount on its own to meet the cess shortfall. The states would have to borrow the amount from the RBI, most likely at an interest rate that the Centre pays for its own loans from the central bank. This will also imply an increase in the states indebtedness. Two, there is now a strong likelihood of the compensation cess to continue beyond June 2022. For manufacturers and consumers, this will be a new element of uncertainty on how long the compensation cess will continue to be levied, affecting prices and demand.

Burden on states set to rise further as their borrowing spurts

Meanwhile, states have begun borrowing from the markets to meet their revenue shortfall. A study by Care Ratings shows that between April and August 2020, 26 states and one union territory have cumulatively raised Rs 2.7 lakh crore through market borrowing, an increase of 53 per cent over their borrowing in the same period of 2019. Remember that a few months ago, the Centre had allowed the states to borrow more up to 5 per cent of their gross domestic product (GDP), against the earlier limit of 3 per cent of GDP. But 1.5 percentage points of this increase in borrowing was linked to fulfilment of conditions by the states including rolling out the one-nation one-ration card scheme,  taking steps to improve the ease of doing business, introducing power distribution reforms and increasing revenues of urban local bodies. But only a handful of the states became eligible for enhanced borrowing because of these conditions. However, the GST Council decision will pave the way for more borrowings by the states without any conditions.

First-quarter stress for India Inc, industrial output and trade

The telltale signs of the Covid-19 pandemic on the Indian economy were all too evident from the performance of many sectors in the April-June quarter of 2020. The results of about 1,630-odd companies, which are available so far, show that their sales plunged by 27 per cent, compared to an increase of 8.7 per cent in the same period of 2019. Worse, profit for this group before tax fell by over 50 per cent and net profit (after tax) fell by an even higher margin of 63 per cent. Similarly, industrial output in the first quarter contracted by 36 per cent, compared to a growth rate of 3 per cent in the same quarter of 2019. The more worrying feature of the industrial output figures was the contraction in manufacturing, estimated at 41 per cent, compared to an increase of 2.4 per cent in the same period of 2019. Manufacturing accounts for 77 per cent of India’s industrial production index. The pointer to the future is gloomy. The capital goods sector, which is seen as a proxy for the pace of investment activity, saw a bigger contraction of 64 per cent in April-June 2020. This was worse than the 3.4 per cent contraction recorded in April-June of 2019. The only sign of hope came from the consumer non-durables, where June saw an output increase of 14 per cent, even though the first quarter performance for this sector was still a contraction of 15 per cent.  The trajectory of India’s foreign trade in the April-July period of 2020 offered no big hope either. While exports fell by 30 per cent, imports contracted by a higher margin of 47 per cent, showing weakness in demand in the economy. Trade deficit fell by 14 per cent, but this was no comfort.

Revenue shortfalls neutralise expenditure containment gains

The Union government’s finances came under intense pressure in the wake of the pandemic. This was manifested in the government’s revenue and expenditure numbers for the April-June 2020 period, as released by the Controller General of Accounts. The fiscal deficit in the first quarter was estimated at Rs 6.62 lakh crore, up 53 per cent over the deficit level in the same period of 2019. More worrying was the revelation that the higher deficit level was as much as 83 per cent of the Budget target. Of course, this was lower at 55 per cent, when compared with the enhanced deficit level based on the increase in the government’s borrowing level from Rs 7.9 lakh crore to Rs 12 lakh crore. But there is no denying that the widening deficit is a cause for concern. There was some relief in the way the government had reined in its revenue expenditure, whose growth was contained at 10.5 per cent, lower than the Budget target of 12 per cent growth. This was helped by lower crude oil prices which brought down the subsidies burden significantly. A 40 per cent increase in capital expenditure, against the budgeted growth of only 22 per cent, was also indicative of the government’s big push towards spending money in new projects in the infrastructure sector. But what must be causing sleepless nights for the government is the fall in the net revenue collections by 47 per cent, compared to a projected increase of 20 per cent. Clearly, reining in expenditure would not be enough. The challenge that will become bigger in the coming quarters will come from the revenue side.

Unemployment trajectory reveals rural-urban divide

Unemployment in India, as measured by the Centre of Monitoring Indian Economy (CMIE), presents a telling commentary on the impact of Covid-19 and the lockdown on the Indian economy. In the immediate aftermath of the pandemic, unemployment in India rose to 23.5 per cent in April 2020, sharply higher than 8.75 per cent in March 2020. This was a huge rise in joblessness and the situation did not change with the unemployment level hovering at the same elevated level of 23.5 per cent. But June and July saw a smart recovery, with unemployment level shrinking to 11 per cent and 7.43 per cent, respectively. The numbers for July were cause for some celebration as these were lower than even the unemployment level of 7.76 per cent in February 2020. For August, the 30-day average at the end of August 27 was marginally higher at 7.96 per cent.  There was, however, some concern over the rural-urban mix in the unemployment numbers. Rural unemployment fell at a pace much faster than that of urban unemployment in the months of June and July, indicating that the rural economy (thanks to the kharif cultivation momentum) was doing better than the economy in urban India, where the salaried joblessness in the organised sector presented a sorry state of affairs. The dichotomy in rural and urban unemployment levels continues even in August – a trend that underlines the deep fault lines in India’s economic growth prospects.

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About the Author

A K Bhattacharya
Distinguished Fellow, Ananta Centre
Editorial Director, Business Standard

After a 10-year long stint with Financial Express from 1978-1988, in different capacities in the areas of news gathering and news management, A.K. Bhattacharya joined The Economic Times in 1988 and functioned as its Chief of Bureau from 1990 to 1993. In 1994, he became its Associate Editor. He joined The Pioneer as Executive Editor in September 1994, stabilised the newspaper before becoming its Editor in 1995. He joined Business Standard in 1996 as Editor, News Services. Was its Resident Editor in Mumbai from July 1996 to September 1997 and helped the newspaper launch its Mumbai edition. From October 1997 to May 1998, he functioned as National Editor leading the paper's news operations. As Managing Editor of Business Standard between June 1998 and April 2000 and as its Group Managing Editor between May 2000 and October 2011, he oversaw the newspaper's news operations and editorial administration. From November 2011 to July 2016, he was the Editor of Business Standard. Since August 2016, he has been the Editorial Director of Business Standard on a part-time basis. He has been writing a regular column - New Delhi Diary - commenting on government affairs, since 1990 - that appeared in The Economic Times, Pioneer and now in Business Standard. Since 1997, he has been writing another column - Raisina Hill - commenting on developments/issues concerning bureaucracy.