Freezing in Cold War 2.0

India should acknowledge that the ‘new normal’ won’t be more than 5% GDP growth

Swaminathan S Anklesaria Aiyar

Stock markets around the world are at record heights. With at least six vaccines undergoing clinical human trials, optimists believe at least one effective vaccine will be available by end 2020 or early 2021. In that case, most humans will be vaccinated in 2021, fear of — and restrictions on — travel and contact will disappear, and the world may return to business as usual.

This optimism is barmy. Even if a vaccine is found and world growth recovers in 2021, the disease, as well as geopolitical developments, are inflicting permanent damage that will lower longer-term growth. India averaged 7% GDP growth for almost two decades. So, many regard that as our baseline scenario. Sorry, but the future baseline may not exceed 5%.

Economy Contracts Covid

The Covid-19 crisis means India’s GDP will crash this year by anywhere from 5% to 10%. Government revenues are collapsing, while emergency relief spending will vastly exceed any spending cuts or new taxes on oil. So, the fiscal deficits of the central and state governments will skyrocket into double digits. The combined effect of crashing GDP and rising fiscal deficits will push up India’s debt-GDP ratio from 72% to, maybe, 85-90% in just one year.

To grasp the enormity of that, consider the Fiscal Responsibility and Budget Management (FRBM) targets. The original FRBM Act provided that the Centre’s fiscal deficit should fall to 3% of GDP by 2008. That has not been achieved 12 years after the deadline, and Covid-19 has now made it a joke.

The N K Singh Committee in 2017 reviewed the FRBM and opted for a gradual glide of the central fiscal deficit from 3.5% of GDP in 2016-17 to 3% in seven years. The committee viewed this not as an end in itself, but as a means to reduce the high government indebtedness that created onerous debt service obligations that gobbled up a third or more of all government revenue. This left too little for the public investment needed to maintain 7% GDP growth.

The committee suggested reducing the debt-GDP ratio to 40% for the Centre and 20% for the states by 2023, adding up to national ratio of 60%. This meant reducing the ratio by around one percentage point per year. Anything more looked politically impossible, apart from being too fiscally austere.

Now Covid-19 is going to raise that debt-GDP ratio by anything from 12% to 18% in a single year. This has put in reverse gear one to two decades of ‘politically do-able’ fiscal adjustment. Hence, the impact will stretch far into the future.

One immediate consequence will be a sharp spike in debt servicing. That will remain high for years to come, even if the Reserve Bank of India (RBI) does its best to keep interest rates low. More debt servicing means less money for essential public investment in everything from health and education to infrastructure. This will hit future growth hard.

Many economists believe that central banks of rich countries — the US, EU, Japan and Britain — can print almost limitless sums of money without causing inflation. But in India, excess money-printing will depreciate the exchange rate, raising the rupee value of existing foreign debt and the annual cost of servicing it. RBI has rightly loosened monetary policy to tackle Covid-19. But that has already sent the rupee from ₹68 to ₹75 to the dollar. In the west, inflation remains near-zero. But in India, inflation is almost 7%, well above RBI’s 2-6% target.

Savings Off the Cliff

Clearly, there are limits to how much money RBI can safely print. Besides, the entire financial savings of India’s household sector are down to 7% of GDP, and government borrowing is much more than that. So, no household savings at all are available to finance private sector growth.

With purposeful economic reforms, India can attract more equity and loans from abroad. But this has to be serviced, and that means accelerating exports too. Alas, India’s export growth has been close to zero since 2013, and world export growth has been only a bit higher.

Politically, the world is turning inward rather than outward. Donald Trump’s ‘Make America Great Again’ finds an echo in Narendra Modi’s ‘Atmanirbhar Bharat’. After the collapse of Soviet communism, globalisation accelerated and lifted all boats. That trend is now being reversed, lowering all boats.

The problem is exacerbated by a new ‘Cold War’ pitting China and its allies against almost everybody else. India is deliberately delinking economically from China.

Suspicions of Chinese security devices have resulted in US trade and investment curbs, which could wreck some of the biggest Chinese companies, and hit the global value chains that accelerated global growth in the past two decades. The great global trade and GDP boom of the 2000s was facilitated by the endof-the-20th century Cold War. Now a new Cold War threatens.

So, both domestic and global developments suggest not just a temporary Covid-19 blip, but permanently slower growth for India and the world. I fear the new growth norm for India may not exceed 5% per year.

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