As India’s economy heads to an uncertain but crucial time, growth is the only answer


The Indian economy is heading for an uncertain but crucial time. It is emerging from a historically mediocre race, with the economy falling from a post-independence record of 7.3% in 2020-2021. This contraction was also an order of magnitude larger than the 3.3 percent contraction of the world economy in 2020. In other words, India was doing poorly both relative to its own. past and compared to the rest of the world. The economy is now only expected to return to its pre-pandemic GDP level in 2022. The pandemic will have effectively cost India two years of lost income growth.

This is not the only bad news. The Covid contraction was preceded by nearly 13 quarters of continued decline in real GDP growth. This backdrop of declining growth and precipitous Covid contraction is likely to undo decades of progress in lifting Indians out of poverty.

A little background on poverty in India is helpful here. The percentage of Indians living below the poverty line (the Headcount Index) in 1985 was almost the same as in 1952. Indeed, India made little progress in reducing poverty between 1952 and 1985. It was only after 1991-92 that India began to make significant progress in the fight against poverty. A 2016 study by World Bank-affiliated researchers Gaurav Dutt, Rinku Murgai, and Martin Ravallion found that over the period 1992-2012, the headcount index declined by about 25 percentage points. On a cumulative basis, the post-reform period lifted over 200 million people out of poverty between 1992 and 2012.

The big difference between the pre and post liberalization phases was the doubling of India’s GDP growth rate. The welfare dividends of this growth reversal can also be found in measures of economic inequality. In a series of recent research papers, Viktoria Hnatkovska and I found evidence of a narrowing of the wage and household consumption gaps between SC / ST and non-SC / ST over the period. 1983-2012. There is similar evidence of a narrowing of the gaps between rural and urban workers over this period. In short, the resumption of growth after 1991-1992 improved the economic lot of many disparate socio-economic groups.

With this background on poverty reduction in India, consider the following facts. A recent study by researchers at Azim Premji University estimates that 230 million people may have fallen below a poverty line of Rs 375 / day in rural India and Rs 430 / day in urban India between January and October 2020. In a separate study, the The Pew Research Center estimates that the number of Indians living below a more conservative measure of $ 2 / day has increased by 75 million in the space of a year since the pandemic has struck. In other words, the economic contraction of 2020 reversed much of the poverty reduction that has been achieved over the past three decades. And, while absorbing these facts, note that these studies do not take into account the devastation of the second wave and its effects on the financial health of households and businesses.

The main lesson to be learned from this story of poverty reduction in India is that the most effective way to help the poor is through faster economic growth. Social protection programs that operate through redistribution schemes can at best be complementary mechanisms providing social insurance against bad luck in the labor market or in health. But, in the absence of growth, relying on redistribution to fight poverty only guarantees many poor people.

So what are India’s growth prospects in the future? Unfortunately, indoor and outdoor conditions seem difficult. Externally, the most favorable aspect is the ongoing return of advanced economies to economic normality. Economic recovery in advanced economies will create demand for products from the rest of the world, including India.

However, outdoor conditions also present potentially severe headwinds.

First, there are signs of rising inflation in advanced economies, which usually induces a monetary tightening cycle. Second, there is growing concern among advanced economies about the need to normalize the stance of monetary policy by raising interest rates from their current levels close to zero. As growth and inflation strengthen in these economies, the pressure to raise rates will only increase. These forces will make foreign capital more expensive, putting downward pressure on an already lukewarm investment rate as the cost of financing rises. Third, public debt levels in advanced economies rose sharply during the pandemic as they responded to the crisis with debt-financed fiscal expansions. There will be a tightening of the belt which will likely temper demand. Fourth, rising world oil prices present yet another external constraint.

Domestic economic conditions were already problematic before the pandemic, causing growth rates to collapse since 2016. NPA surplus in the banking sector has not been rationalized. The economic contraction of the last year has only made the situation worse. The uncertainty surrounding the economic environment had already led to a slowdown in investment before 2020. None of this has dissipated. On the contrary, the botched vaccination policy has now created additional uncertainty regarding the state of public health in the future.

Given the dire shortage of available fiscal resources, the most promising path for the government is to adopt regulatory reforms in the labor and land markets that go beyond collecting different codes in a single head and l ‘call a reform. India’s salvation lies in the growth of large-scale, low-tech manufacturing. It is the only sector that can employ the 10 million new workers entering the workforce each year at wages that reflect their aspirations. Without reforms that reduce the risks of hiring labor and acquiring land, this sector will not develop. And divestment from the public sector must be adopted on a war footing.
The fiscal costs of far-reaching reforms are low, but their economic returns are potentially high. Of course, meaningful reforms have potentially high but uncertain political costs. It’s time to pay the piper.

This column first appeared in the print edition on August 12, 2021 under the title “Time for in-depth reforms”. The author is a research professor of economics at the Royal Bank, University of British Columbia


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