Four policy measures that will support the growth recovery

First, policymakers must acknowledge the differential extent of hit across sectors. The V-shaped recovery in the headline GDP number hides more than it reveals as it is just an average - sectors such as aviation, hotels, commercial vehicles, real estate and capital goods would see 4-5 times the fall in GDP in FY21. The recovery in these sectors in FY22 is also likely to lag relative to the recovery in GDP. The government must ensure targeted support to these sectors in order to prevent the loss of productive capacity and avoid labour market shocks and debt overhangs.

Second, the government must ensure that policy support is not withdrawn pre-maturely, especially on the fiscal front, as a sustainable and broad-based pick-up would be contingent upon policy support.

There are concerns that the net fiscal impulse is set to decline in FY22 – the consolidated fiscal deficit-to-GDP ratio is expected to narrow to high single digits from expectations of around 14-15 percent in FY21. Besides, the government spending-to-GDP ratio is also expected to fall in FY22 after expectations of a sharp rise in FY21 (as GDP is expected to fall more sharply than government spending).

Notwithstanding this, the Centre and the States must frontload their FY22 expenditure to provide adequate support to the recovery in the first half of the fiscal until mass vaccination becomes a reality.

Further, they could also make up for the lower fiscal impulse by announcing growth supporting policy measures in their FY22 budgets. Besides, the quality of spending, in terms of the capital-revenue spending mix, is also expected to deteriorate in FY21 and a reversion on this front will play an important role in supporting public investments and raising the government spending multiplier.

Finally, the States have much larger budgets (in aggregate) and more discretionary spending room vis-à-vis the Centre. The quality of their spending would be key to supporting economic activity.

Third, policymakers must recognise that India cannot grow at 6-7 percent on a sustained basis with credit growth in low single-digits. While bank credit growth has eased to a little over 5 percent, NBFC credit growth has also fallen to single digits.

This slowdown is on account of risk aversion, as private sector banks and NBFCs (which have accounted for 75-80 percent of incremental credit in the last three years) are extremely cautious to grow their books, given the possibility of a spike in bad loans.

The main reason behind this risk aversion is India’s poor record of resolution of bad assets. Unless, the government addresses this issue with targeted measures that involve a quick clean-up, risk aversion is likely to sustain into 2021 and constrain India’s growth recovery.

Lastly, in its October World Economic Outlook, the IMF had highlighted that the crisis is expected to lead to scarring, by damaging supply potential across economies. This would imply that, notwithstanding the sharp rebound in 2021 (owing to the base effect), the medium-term growth potential may actually come under stress.

The RBI must take cognisance of this while reviewing its monetary policy framework and tilt in favour of growth while tolerating slightly higher inflation levels in the medium term. It could do so by adjusting its inflation target of 4 percent +/-2 percent or even accepting an uneven band around the central target to allow for slightly larger deviations on the upside vs. the downside.

This would provide the central bank some additional policy space and would help avoid premature policy tightening and output sacrifice.

(Sachchidanand Shukla is Group Chief Economist, M&M. Views are personal. Rahul Agrawal, economist, M&M assisted with inputs.)