Working Paper No1, 2020 /Goa Institute of Management, Panaji

In this paper we bring out the performance of the Indian economy and review the approach of macroeconomic policy especially demand management in the Indian economy. After the shock of the Global Financial Crisis (GFC), India’s economy did not dip much due to the well-directed fiscal stimulus by the government early on. The government could persuade an RBI which was still “fighting” a supply-side inflation to expand liquidity to at least reverse the sharp fall in liquidity that had taken place due to the contagion and capital flight brought about by the GFC.
However, as the fiscal stimulus was being withdrawn from 2011-12, the RBI tightened to raise interest rates, which from 2012-13 put brakes on the economy. Tight monetary conditions continued almost until 2016. The RBI saw rising inflation not only in the non-core part of the CPI, but also on the core, thereby “necessitating” this counter action, in its view Additionally the RBI also in “defending” the currency kept higher than desirable interest rates. Closer examination would reveal that much of the rise in the core inflation was spurious since it was on account of the house rents “going up” due the 6th Pay Commission award which was first notified for the government employees in mid-2009. The spurious impact on the core would have been as high as 4%. [Even today in the midst of the COVID-19 Crisis, the large rise in the core now on account of the delayed 7th Pay Commission implementation confuses not only the RBI but the media as well].
The year 2013-14 also saw the RBI move to “inflation targeting”, and to continued lightening which kept interest rates record high and created a large fisher open which attracted expensive gross foreign equity capital inflows, though on a net basis the flows were incomparably small in relation to the period of high growth before the GFC – the “Tiger” Period (2003-04 to 2007-08). The “taper tantrum” saw even further rise in interest rates. More importantly for a period as long as 10 years with only short breaks, the low end bond yields remained well above the repo rate, signifying that the repo windows were prematurely closed and the RBI was de facto carrying out credit rationing as well, negating the repo rates as “policy rates”. From 2014-15, and only after the economy had slowed down considerably that the interest rates could begin to come down, and even then the anomaly of the market rates being higher than the “policy” remained. Inflation targeting brought with it many problems for the RBI and the fact that forecasted inflation (conditional on the RBIs own measures) was always higher than realized inflation by a wide margin, which seriously questions the RBI’s approach to monetary policy. Similarly, its expectations surveys are off the mark systematically by a wide margin. Even more importantly the RBI’s propensity to react to current CPI inflation than to forward looking core inflation means that financial markets (over the longer term and longer maturity instruments) do not react to even the lowering of the low end rates, since this approach of the RBI makes the future very uncertain, and therefore the first leg of the transmission is hurt by the modus operandi of the RBI itself.
Moreover, there is very little support to the RBI’s contention that even a supply side inflation needs to fought from the demand side to prevent inflationary expectations from building up, since not only have expectations (correctly measured) not shown any secular trend except downwards, but food inflation which drove everything else during this period, can hardly be affected by demand side measures, since the income elasticity of food is very small, even for a poor country like India now that there are few people below the poverty line. The point that India may be at a phase (encountered by all densely populated countries that pierced the middle income barrier) when the terms of trade need to rise in favour of agriculture, to bring the agricultural sector into the home market in a vigorous way, has missed the RBI
On the fiscal side a variety of measures adversely affected investment, and animal spirits. The ‘policy paralysis’ during the last years of the UPA government was the turning point. However, with the Modi-I government the large reduction in anti-poverty programmes and especially the Mahatma Gandhi National Rural Employment Guarantee Scheme (MNREGS) allocations, the underspending from the budgetary provisions in the first two budgets of the Modi government (as a side effect of the extreme centralization of power in the PMO), besides the “unconditional” commitment to the fiscal deficit targets, further contributed to the demand decline. From the third year onwards of Modi-I the policy and action uncertainties including those let loose on the automobile sector took their toll. The talk of banning diesel vehicles was highly damaging to the industry, that had just made the transition to being able to meet Bharat VI norms.
From 2012-13 growth had fallen but the official 2011-12 series did not reflect the same. Growth from 2012-13 to 2017-18 could not have been more than 5.5% p.a. most probably under 5%. And the investment growth rate especially of the private sector had all but collapsed. Investment share in GDP came down to a mere 32% of GDP from its high levels of 36 to 37% over the “Tiger” period. Public investment in infrastructure often directed sub-optimally from the productivity and value creating standpoint, was dominant. Private investment saw the longest period of near stagnation, ever since its faster growth from the mid-eighties and its acceleration after the Great Liberalisation (GL) of 1991-92, 92-93. The economy seemed to more than recover from the decline brought about by the demonetization, from late 2017 onwards, but the growth of around 7.8 % over three quarters, quickly gave way to a slow down reaching as low a rate as 3% on the eve of the COVID-19 Crisis.
While nearly all the programmes of the Modi government were about increasing public and social value, the poor capability of the government at the organizational, coordination, and strategy and design levels cheated the NDA of transformative second generation reforms. Instead, most of these fizzled out. There was little of the creativity of the earlier National Highway Development Programme (NHDP) nor of the Prime Ministers Gram Sadak Yojyan (PMGSY) under Vajpayee, when the government had the wisdom to accept and implement a well-crafted NHDP that actually came from the IDFC. Only the Direct Benefit Transfers were improvements. But even here the realized gains were far below the potential. The task of combining (structural and tax) reforms with macroeconomic demand management in a positive way proved beyond the capability of the government. Thus even excellent and politically difficult reform like the introduction of GST, while largely successful in itself, led to increased effective tax rates (precisely because it improved compliance) adding to the downward pressure on demand, when measures to counter act the same could have been used.

Bank lending, which was always a problem given governmental interference and a “laundry-list approach” to regulation pursued by the RBI, went from bad to worse. Much of the lending during the period of the fiscal stimulus was hurried, and began to worry the PSU banks once the slowdown happened. The slowdown itself contributed to their bleak situation which in turn negatively affected whatever little transmission they could have affected. The delay in their recapitalization affected the Non-Banking Financial Companies (NBFCs) and the real estate sector to create a gridlock on lending. The frameworks for private investment in infrastructure (except in the highways) were inappropriate The external sector was benign but the government hardly used the opportunity of falling oil prices. This was because of its single minded pursuit of reducing the fiscal deficit often with the limiting perspective of managing a family budget. An entirely uncoordinated and knee-jerk approach, and literal interpretation of the prime minister’s slogan and programmes, by the bureaus meant that many ambitious programmes hardly went beyond tokenism. The steady growth of the world economy did not positively affect India through export growth, as much as it could have, since real effective exchange rates continued to be high relative to its competitors in East Asia that now included Vietnam.

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Morris, Sebastian, Slowdown and Crisis in the Indian Economy - A Study of the Macroeconomic Developments between the Global Financial Crisis and the COVID-19 Crisis (2011-12 to 2019-20) (December 01, 2020). WPS No. 01/EC/December 2020, GIM Working Paper Series, Available at SSRN: or

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