Das is right, Subramanian is wrong

Last Friday, Shaktikanta Das, the Governor of the Reserve Bank of India (RBI), finally admitted to what had become fairly obvious by then: that the Indian economy will contract during the current financial year (April 2020 to March 2021).

As Das put it: “GDP growth in 2020-21 is estimated to remain in negative territory.” GDP or gross domestic product is a measure of the economic size of a country. When Das said that GDP growth will remain in negative territory during this financial year what he meant was that the size of the Indian economy will contract.

If Das turns out to be right, as he is more than likely to be, this will be the first time the Indian economy shrinks since 1979-80. The economy had contracted by 5.24% in 1979-80. This was the year of the second oil shock, when due to a revolution and regime change in Iran, oil prices had gone through the roof. In fact, in the last six decades, this is only the fifth time that the Indian economy is set to contract. The other four times were between 1960-61 and 1979-80.

Getting back to the present, Das did not say by how much the economy will contract, preferring to wait till the end of the month when more data providing greater clarity will become available.

Having said that, there are other projections that are already available. As per the National Council of Applied Economic Research (NCAER), economic growth in 2020-21 is expected to contract by 12.5%. But this projection didn’t take into account the government’s so-called economic package amounting to Rs 21 lakh crore, most of it available to businesses of all sizes to borrow.

As per the economists at Goldman Sachs and Nomura, the Indian economy is likely to contract by 5% in 2020-21. Economists at Bernstein expect it to contract by 7%. Amongst all these predictions, the government’s Chief Economic Adviser Krishnamurthy Subramanian expects the economy to grow by 2%.

Now, that looks highly unlikely and there is a simple logic to it. Large parts of the economy have been shut since the last week of March and through April and May. Parts of it have begun to open up only this week and that too gradually.

Even assuming that half of the economy was working in these two months, one month’s economic activity for this year has been more or less destroyed. In other words, 8.33% of the economic activity for the year is gone. Also, the negative economic impact of Covid-19 is unlikely to end even if a larger part of the economy opens up in the weeks to come.

There are multiple reasons for it. Physical distancing is unlikely to end. Though the economy is being opened up, the number of Covid cases continues to rise in the economically more important parts of the country (Maharashtra, Delhi, Gujarat, Tamil Nadu, to name a few states).

In this scenario, more and more people are likely to stay at home. When people stay at home, they don’t go out and spend money. Businesses like cinemas, malls, restaurants, apparel stores, hair-saloons, jewellery stores, electronic stores, etc., will lose out big time.

In fact, even banks will see a fall in their non-interest income or the money they earn beyond their basic business of raising deposits at a certain interest rate and giving out loans at a higher interest rate.

To tide over the crisis, businesses are firing employees and slashing their salaries. Many individuals working in the informal sector have already lost their jobs. This explains their rush to get home from India’s bigger cities to their native places. Without work and without money, there wasn’t much of an option left for the migrant workers.

Many firms are not honouring new job offers they had made. New recruitments have also been put on hold. Vendor payments have been stopped. In this environment, it is difficult to expect people to go buy things beyond the basic stuff they need for survival. With the economic future looking bleak, automobile sales and housing sales will also take a beating. This is not the time when people want to commit to paying EMIs for years to come. The interesting thing is that both automobile sales and housing sales had slowed down during 2019-20. If 2019-20 was bad for these sectors, imagine what’s going to happen this year.

Also, even before Covid-19 stuck, the psychology of a slowdown was setting in. Now, we have the psychology of a recession setting in. What does this mean? As more people lose jobs and see salary cuts, all of us will end up knowing someone who is feeling the pain because he has lost his job and can’t find a new one. Or has seen a substantial drop in salary and is struggling to make ends meet. Or has seen his small business simply shut down.

In this scenario, economic survival will become key. And when this happens, people will hold on to the money they have and spend only on the things that are most required -- food, medicines, mobile and internet, housing rents, home loan EMIs and other EMIs already being paid and fast moving consumer goods (soap, detergent, shampoo, toothpaste, toothbrush, etc.). To cut a long story short, when someone loses his job or faces a cut in salary or his business shuts down, his behaviour on the spending front cannot continue to remain the same.

But with the psychology of a recession in place, even the behaviour of people who are not in trouble becomes similar to the behaviour of people who are in trouble. This is why it is safe to say that Das is likely to be right about the Indian economy contracting this year. Our troubles might just be starting.

(The writer is an economist and author of the ‘Easy Money’ trilogy)