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Nirmalaji, what about growth beyond FY22?

By Shankar Acharya
March 04, 2021 09:54 IST
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We will find it difficult to exceed an average of 5 per cent growth in the medium term, warns Shankar Acharya, the former chief economic adviser.

Illustration: Dominic Xavier/

Budget 2021 has been framed against a backdrop of the most extraordinary challenges confronting the economy since Independence.

Because of Covid and the lockdown, economic output (GDP) crashed by an unprecedented 16 per cent in the first half of fiscal year 2020-21 (FY21), before recovering smartly post-lockdown, according to official projections, to near FY20 levels in the second half.

The initial, officially projected full FY21 fall in GDP was a record 7.7 per cent.

The associated employment loss was huge and the recovery has been much weaker, with many millions still suffering from continued loss of jobs and earnings.

Inflation, surprisingly, remained high for much of FY21.

Revenues plummeted and expenditures rose, leading to record fiscal deficits and government debt levels.

Foreign trade collapsed and recovered somewhat weakly.

In this challenging context, the finance minister and her team have presented a decent Budget.

In particular, she has done wonders in restoring transparency and veracity to Budget numbers, which had become seriously misleading in recent years.

Second, she has announced her government's decisive commitment to privatisation of generally weak government enterprises, bringing back memories of the Vajpayee-Shourie days nearly 20 years ago.

Third, she has boldly announced the beginning of a programme to privatise chronically ailing public sector banks, which continue to dominate India's long-stressed banking sector.

This is the only viable path out of the hugely expensive, perpetual cycles of bad loans, diminished capital, exchequer-financed recapitalisation and more bad loans.

Stepping back, it would be useful to indicate the big macro challenges facing India at present and assess how well the Budget has addressed them. The challenges are:

1. Restore output levels to assure strong growth in FY22;

2. Encourage rapid medium-term growth beyond FY22, say, in the years FY23-27;

3. Mitigate the massive employment and livelihood scarring inflicted by the pandemic, lockdowns and earlier shocks such as demonetisation;

4. Avoid consumer inflation reverting to 6 per cent-plus levels;

5. Encourage the recovery of trade and exports, especially with dynamic East and Southeast Asia.

If official estimates are correct, GDP has already attained the FY20 level in the second half of FY21.

That means, as a matter of arithmetic, even if there is no further growth in FY21 (over the FY20 level), GDP will grow by about 9 per cent in FY22.

Since further growth of about 1-3 per cent could well occur, y-o-y growth in FY22 could well range around 10-12 per cent.

With its continued high fiscal deficit of nearly 7 per cent of GDP (perhaps 11 per cent including the states), due emphasis on health and infrastructure spending and some confidence-boosting reform measures, the FM's Budget assures double-digit growth in FY22.

Ensuring high growth of 7 per cent-plus in the medium term will be far more challenging.

Past policies and the pandemic shock have compounded three major dampeners to medium-term growth prospects.

First, there is the massive overhang of government debt (at a record 90 per cent of GDP by end March 2021), pumped up by the unprecedented 14 per cent combined (Centre plus states) deficit of this pandemic year.

Given expectations of the continued high 11 per cent combined deficit in FY22, the stratospheric government debt ratio is unlikely to shrink much during the year.

Second, going by the recent Reserve Bank of India's projections, the non-performing assets ratio in the banking system could well soar to 14 per cent or higher by September 2021, greatly weakening the system's capacity to finance productive economic activity and investment.

The Budget announcements of privatisation of government banks and the setting up of a quasi 'bad bank' offer some hope for the future.

But even with high quality implementation, these will take years to materially relieve the extraordinarily high levels of stress in Indian banking.

Third, the past three years of rising protectionism in our trade policies since 2017 will extract an increasing toll on our growth prospects.

On this point, the Budget was disappointing, with its continuation of substantial tinkering with already high Customs tariffs, mostly upwards.

The Budget's aspirations of greater Indian participation in global and regional value chains were ill-served by such pedestrian tinkering.

In a nutshell, this Budget does little to assure strong growth beyond FY22.

We will find it difficult to exceed an average of 5 per cent growth in the medium term.

Nor is there much in the Budget to mitigate the woeful situation with regard to jobs and livelihoods.

As the official labour force survey for 2017-2018 pointed out, all indicators of labour market health were at dismal lows.

Since then, two years of sharply slowing economic growth and the massive blows of the pandemic and lockdown have made matters worse, especially for the informal sector, which accounts for at least 85 per cent of India's labour force.

Yes, there will be some recovery in jobs as GDP continues to recover from the nadir of spring-summer 2020.

However, as the contemporary data from the ongoing surveys by the Centre for Monitoring the Indian Economy show, the situation remains pretty grim.

Fourth, the government and the RBI will have a hard time containing inflation below 6 per cent in FY22.

Even if all revenue and expenditure targets of the Budget are met, financing the second year of exceptionally high fiscal deficits will entail net market borrowing of nearly Rs 10 trillion, a good 60-70 per cent higher than in the years immediately preceding the pandemic.

This order of elevated borrowing will necessarily require the RBI to keep liquidity conditions exceptionally lax if the borrowing programme is to be successfully executed, without leading to significant increases in interest rates.

With private activity recovering, excess liquidity is likely to stoke higher inflation.

Had the Centre's budget deficit been even one per cent lower (perhaps through the imposition of a temporary 'Covid tax'), the chances of containing inflation below 6 per cent would have been markedly higher.

Finally, as already noted, the Budget did not reduce our protectionist trade policies.

So, the long-continuing decline in our share of exports-to-GDP is likely to persist, thus weakening the medium-term viability of our balance of payments and muffling the growth impulses that will emanate from a recovering world economy.

But then, we cannot expect one Budget to solve all our economic problems!

Shankar Acharya is Honorary Professor at ICRIER and former Chief Economic Adviser to the Government of India.

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