GDP contraction: No easy solutions but a chance for deep economic reforms

Emerging from the biggest GDP contraction in recent times will take time but the govt should undertake soul-searching about how thin it wants to spread itself

If you follow the news media closely or even if you don’t, you would know by now that the Indian gross domestic product (GDP) for the period April to June 2020 contracted nearly by a fourth or 23.9% to be very specific. GDP is the measure of the economic size of any country during a certain period.

But what does this really mean? GDP growth is ultimately a reflection of whether economic transactions are growing or not. Or to put it simply whether people are buying and selling more things than they did in the past. And when this does not happen, the GDP contracts or the economy contracts.

Let’s try and understand this through an example. Let’s say it’s the first weekend of the month and your salary has just hit the bank account. With money in your pocket you feel like going to the multiplex at the local mall to watch the latest blockbuster. There you not only watch the movie but also eat out at the food court and buy a pair of jeans you have been eyeing for a while.

Now what is happening here? Every time you are buying something you spend money. This money is going into the accounts of businessmen who are selling you stuff. It is then used to pay the employees of these businesses, the suppliers, the shop rentals and so on. Everyone who gets paid like this can then go out and spend money in the same way as you did.

This is called the multiplier effect of spending. With Covid-19, as people have stayed at home, this multiplier effect has broken down to a large extent. This has, in turn, had a further negative impact on jobs and spending.

Private consumption during April to June contracted 26.7%. Not just that, with a physical lockdown in place and migrant labour moving away from the economically well-off parts of the country to their homes, construction and infrastructure building took a backseat between April and June. In fact, construction contracted by a little more than 50% during the period. This played its part in the economy contracting.

Also, in an environment where consumer spending took a beating, investment in the economy contracted by 47.1%. Companies ultimately make things for people to buy. And if that space is contracting, there is no point for companies to keep investing in the economy.

Bumpy road to recovery

So, what is the way out of this? Firstly, in the months to come, private consumption will improve and so will investment as a result. But it will take a while for both consumption and investment to reach pre-Covid-19 levels.

With Covid-19 now spreading at the rate of more than 85,000 cases per day, it is no longer just an urban India phenomenon. As it spreads to semi-urban and rural India, it will impact consumption, though not in the same negative way as it did between April and June. We have to brace for this.

To ease the pressure on consumption, banks have cut interest rates in the hope of people and businesses borrowing and spending more. But that hasn’t happened. People and businesses borrow and spend more when they are confident about their economic future. Right now, the confidence is missing.

In this environment, companies and brands need to offer discounts and offers to get people to consume again. In fact, a bit of that is already on and as the festival season comes in, more offers and discounts will hit the market.

One thing that the government can clearly do to get consumption going again is to reduce the GST on two-wheelers from 28% to 18%. What it loses out in taxes per unit of sales, it will make up for in volume. Also, if more two-wheelers sell, everyone from tyre manufacturers to steel companies will benefit.

The government, for its part, needs to step in and spend more, in the process create some economic activity. Government expenditure between April and June went up by 16.4%. It put in money into female Jan Dhan accounts. Now is the time to put money in male Jan Dhan accounts as well.

The government also increased allocation and spending through the Mahatma Gandhi National Rural Employment Guarantee Scheme. It is important to keep offering work under the scheme through the year. But given the gravity of the collapse, this has clearly not been enough. Hence, everyone expects the government to do more. Now doing more needs more money. The trouble is that the government tax collections have collapsed by close to 30% between April and July this year.

It can indeed borrow more. The Reserve Bank of India can also print money and fund government expenditure. In fact, it is already doing that to some extent. But all these moves come with their own set of negative repercussions. Printing money can lead to higher inflation as a higher amount of money chases the same amount of goods and services. It can also lead to the rupee depreciating against the dollar quickly and the foreign investors, in turn, wanting to leave India. This is something that can disturb the general macroeconomic stability of the country.

And that explains the reluctance of the government on this front.

Not letting a good crisis go to waste

But while the government is clearly tied on the spending-more front, it can possibly push in more economic reforms at this point of time. One area that clearly needs reform is the Goods and Services Tax system, which instead of freeing up the Indian economy has acted in a negative way. Another area that clearly needs reform is India’s public health infrastructure.

The big philosophical question that the government needs to try and find an answer for, if it is really interested in development, is, whether it should spread itself as thin as it currently does, or should it concentrate on a few main areas like defence, physical infrastructure, education, agriculture, external affairs, etc. This lack of concentration has harmed India quite a lot over the years and any sort of focus will really help.

While these reforms may not lead to immediate benefits they will work well for the economy in the longer-term, something which we shouldn’t miss out on with the current focus on Covid-19.

Beyond that there isn’t much that the government can do. Also, it is worth remembering here that the Indian economy was already in trouble before the Covid-19 pandemic struck.

To conclude, it is worth saying that if all problems had solutions, they wouldn’t be called problems in the first place.

(The writer is the author of Bad Money)