The RBI's Report on Currency and Finance (RCF) 2021-22, released recently, busts the myth around India's quick V-shaped recovery from the pandemic crisis. A GDP growth of 8.9% in FY22 (AE2) – taking the GDP 1.7% higher than the pre-pandemic FY20 – seemingly conveys this message but this is grossly misleading.

The RCF (which the RBI says reflects the view of its authors) works out the total output loss due to the pandemic at ₹52.6 lakh crore in FY21, FY22 and FY23 (₹19.1 lakh crore, ₹17.1 lakh crore and ₹16.4 lakh crore, respectively). It says, "India is expected to overcome Covid-19 losses in 2034-35" – that is, it would take India 13 long years to recover from the pandemic setback to go back to the pre-pandemic growth level.

In RCF's assessment, the pre-pandemic growth is not 3.7% of FY20, but the annual average of 6.6% during FY13-FY20 – which is a prudent and logical way to look at the state of the economy. It also assumes an annual average growth of 7.5% during FY24-FY35 (13 years) for this recovery to take place. This it does on the basis of -6.6% growth in FY21, 8.9% in FY22 and the assumption of 7.2% growth in FY23.

This is the best-case scenario. There are reasons to be far more pessimistic about future growth and RCF's projection to hold – not the least because at -6.6% India's growth in FY21 was one of the lowest in the world.

Robustness of the projection

RCF's projected recovery (by FY35) will go haywire if any of the key best-case-scenario assumptions go wrong. For example, if the future growth is less than 7.5% (during FY24-FY35), the recovery would be pushed beyond FY35 – that is, more than 13 years to recover from the loss.

So would be the case if the FY23 growth is less than 7.2% – given the high inflation and the Russia-Ukraine war exacerbating inflation and supply constraints, both of which will impact growth. Inflation dampens consumption, which is already subdued due to the prolonged pre-pandemic slowdown and the pandemic loss of jobs and businesses. When that happens, production of goods and services go down. Supply constraints would raise cost of production, reducing consumption. They create vicious circles of their own.

The RCF flags several concerns about India's current economic policy.

The first one is "the large surplus liquidity overhang". It warns that if this surplus is not reined in quickly it will lead to further inflation. It advises the RBI to focus on price stabilisation, rather than push growth through liquidity infusion. The RBI may have claimed that the RCF report presents the view of its authors but that of the central bank but it had itself warned twice in 2021 that excess liquidity (and the fiscal stimulus) posed "macro-financial risks" if prolonged any longer.

The second is, continued fiscal stimulus like capital expenditure. The RCF says it helps (multiplier of capex is positive) when growth is slow and demand is low but when an economy is expanding (which is what would be for growth at 7.5% during the 13 years of FY24-FY35), the multiplier effect of capital expenditure "turns negative", "signifying the detrimental impact of expansionary fiscal policy on growth".

The third is growing debt. India's general government (Centre plus states) debt-to-GDP reached 90.4% (Economic Survey of 2021-22). The RCF says in the best-case scenario, the debt may not decline below 75% in the next five years, while the desirable level to secure medium-term growth prospects is 66%.

Therefore, it calls for "rebalancing of monetary and fiscal policies" – which would mean the RBI to reverse its accommodative approach and focus on price stabilisation (control inflation) and the government to cut down fiscal stimulus (capital expenditure and other incentives).

Both are easier said than done.

The real challenge is for the RBI to effectively raise interest rates and rein in inflation, which it has been reluctant to do in the past few months when inflation breached its upper tolerance level of 6% and the Ukraine war broke out. It has seemingly been more concerned to keep the central government's interest outgo on debt (more than 90% of which from internal sources) under control – as Fortune India had explained in "Why RBI is coy about raising interest rates". Now the next monetary policy meeting will be held in June.

As for the government to check fiscal stimulus, it may be pointed out that it is in the FY23 budget that the Centre went aggressive in pushing capital expenditure to attract private investment and boost demand. Since FY17, the Centre has been waiting for private investment to revive. It slashed corporate tax (worth of ₹1.45 lakh crore) starting FY20, even while facing fiscal constraints. The RBIs Financial Stability Report (FSR) of January 11, 2021 had marked "lack of robust private sector investment" as the number one risk to the economic recovery. Its FSR of December 2021 said it was still waiting for the revival of private investment.

The dangers of prolonging fiscal stimulus to help private sector is known. Recall how the UPA government took its stimulus packages too far in response to the 2007-08 Great Recession and then Finance Minister P Chidambaram was forced to admit that it had led to higher fiscal deficit, inflation and slowdown in growth. Now the focus of the present Finance Minister Nirmala Sitharaman is on significant boost in capital expenditure in FY23. An overnight change, as the RCF wishes, is unlikely in the current fiscal.

What will drive the growth if the RBI and the government pull back on their growth drive?

The RCF says "restoring and recreating a policy environment" to ensure "private sector-led growth" would be required.

Now the RCF has joined the RBI and the government in hoping for private sector to drive its presumed 7.5% of annual average growth it says is needed for the next 13 years to overcome the pandemic loss.

Why 7.5% growth is too optimistic

There are several sound reasons to be pessimistic about 7.5% annual average growth for the next 13 years and private sector, rather than the government and RBI, driving it.

Even at the highest growth phase of India, during FY05 to FY15 when Manmohan Singh was Prime Minister, the average annual growth was 6.9% (2011-12 GDP series, constant prices). To assume 7.5% growth for the next decade and more after a prolonged economic crisis – starting with the twin shocks of the demonetisation and GST and now a prolonged pandemic crisis (growth was 3.7% in FY20 and plunged to -6.6% in FY21) – is too optimistic.

The present economic condition does not give such high hopes.

The full impact of the economic shocks, beginning with the demonetisation of November 2016 on the income of households (key to reviving consumption demand), is not known. What is known is that the job crisis has worsened and more people have slipped into poverty. That is why 62.5% of the population need to be fed with "free" ration, over and above "subsidised" ration. Import substitution policy since 2014 has hurt both imports and exports, thereby depriving an export-led growth prospect. There is no evidence that it has boosted manufacturing, as was promised.

Private sector investment has fallen drastically from 13.6% of the GDP in FY13 to 11.1% in FY20 (the last fiscal for which data is available). Gross fixed capital formation (GFF) – overall investment in the economy – has fallen from 34.3% of the GDP to 28.3% in FY22. Bank credit growth is driven mainly by personal loan for consumption, rather than for production of goods and services by industry and services.

For India to now claim that it is back to being the fastest growing major economy in the world (with 8.9% growth in FY22) remains to be tested on the ground.

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