India set to witness first recession after 1980s

India set to witness first recession after 1980s

The government has tried to downplay fears with top officials suggesting economy could get back to pre-Covid-19 level faster than expected

Representative image. Credit: iStock.

All eyes are set on the economic growth numbers for July-September quarter to be released next week. Not because India is set to post a recession after nearly four decades, as a near 9% contraction in the economy in the quarter gone by has already been priced in. Important to watch will be the year ahead prognosis and how soon the government believes the economy will break out of contraction of the past six months.

Amid the Covid-19 pandemic, the economy has contracted 23.9% in the April-June quarter. However, the recovery beginning October has been stronger than market expectations. High frequency indicators such as the GST collection, PMI manufacturing and services, E-way bills, core sector index and exports have turned corner suggesting a sharp rebound. But many economists suggest it could be partly due to the festive demand.

The unrelenting pressure of inflation, despite supply side steps such as reduction in import duty on certain items like pulses and imposition of stock limit on onions, may indicate there is no let-up in sight. Add to that, higher fuel prices, goods and services have led to cost-push inflation. Data compiled by brokerage Anand Rathi suggests, at 7.6%, India has the third highest retail inflation rate among the G-20 countries. With this, it is bucking the overall global trend in low inflation. High food inflation is the main reason for high retail inflation in the country. Since food prices are largely domestic driven, internal rather than global factors are driving up the inflation rate in India.

The Reserve Bank of India has warned there is a grave risk of generalisation of price pressures, unanchoring of inflation expectations feeding into a loss of credibility in policy interventions and the eventual corrosion of the nascent growth impulses that are making their appearance.

The second major risk to the economic growth, according to the central bank, stems from the global economy now being at risk from the second wave of Covid-19. Should external demand collapse again as commodity prices seem to foretell, the recent recovery in exports could become stillborn. Lurking around the corner is the third major risk – stress intensifying among households and corporations that could spill over into the financial sector.

The government, however, has tried to downplay these fears with top officials suggesting economy could get back to pre-Covid-19 level faster than expected. Their optimism is based on the reforms being undertaken in the infrastructure sector.

Some 7,000 projects have been identified under the National Investment Pipeline and Finance Minister Nirmala Sitharaman believes once the money goes into infrastructure creation, it will have multiplier effect. Recently, the government has also granted 100% income tax exemption to Abu Dhabi’s sovereign wealth fund. It will make investment in the specified infrastructure sector. Transport, energy, social and commercial infrastructure, water, sanitation and communication have been identified as the key sectors, investment on which would be tax exempted in India, albeit with conditions.

The government is also coming forward for more and more production-linked incentives in electronics, telecom and other sectors to boost large-scale domestic manufacturing. These will not only result in enhanced manufacturing capabilities but also provide jobs on a bigger scale.

But amid vast infrastructure reforms, a major impediment is the country’s import substitutions policy. Recently, the Niti Aayog’s first Vice Chairman and now a Columbia University professor Arvind Panagariya cautioned that import substitution policy could majorly stand in the way of India’s high growth potential. According to him, no emerging economy has ever done well without investment and exports. To recall, India’s 2002-2010 growth boom was backed by exports that grew 18% a year for eight years, which was twice the rate of headline economic growth.

When the post Covid-19 reconstruction begins, India’s banks will be laden with a huge pile of bad loans, its public sector institutions will have higher debts to service and the government finances will be under pressure. In these circumstances, shutting the door to the world will do more harm.

Economists believe India needs right balancing of its policies and reform measures to optimise its growth potentials. The key growth drivers may have done well for the past couple of months amid pent up demand, but there is no guarantee they would continue to perform well when the pandemic has altered people’s behaviour and changed their priorities.

International institutions and brokerages may have turned sanguine on India’s economy but they are also cautious.

Get a round-up of the day's top stories in your inbox

Check out all newsletters

Get a round-up of the day's top stories in your inbox