The National Council of Applied Economic Research (NCAER) has said it sees the economy registering a contraction of 7.3 per cent in FY21.

Releasing its ‘2020-21 Mid-Year Review of the Indian Economy’ at a webinar, the NCAER has forecast the annual CPI inflation at 6.7 per cent. It has revised its GDP growth forecasts for Q3 and Q4 to 0.1 per cent and 2 per cent, respectively. CPI headline inflation is forecast at 7 per cent in Q3 and 6.3 per cent in Q4.

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The NCAER GDP forecast of (-) 7.3 per cent for FY21 is only marginally higher than the RBI forecast of (-) 7.5 per cent.

Long-lasting impact

Shekhar Shah, Director General, NCAER, said that the ongoing recovery notwithstanding, hysteresis, the long-term effect of sharp contraction of GDP in 2020-21, is likely to be long-lasting. The economy will have to grow at more than the previous trend rate for it to catch up with its pre-pandemic growth level. Conventional macroeconomic policies alone will not do. These will have to be supported by deep and wide ranging reforms, especially in the financial sector, power and foreign trade, he said.

Additional reforms in health, education, labour and land are also urgent, but these will require close coordination between the Centre and States in a spirit of cooperative federalism since these are in the main State subjects in the 7th Schedule of the Constitution, Shah added.

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NCAER estimates that the combined fiscal deficit of the Centre plus States will amount to over 14 per cent of GDP for the full financial year after factoring in the projected (–) 7.3 per cent contraction of GDP. “Even if we count only the fiscal impulse, i.e., the excess of the 2020-21 fiscal deficit over that of 2019-20, this amounts to a stimulus of over 7 per cent of GDP. Taken together with RBI liquidity infusion of well over 6 per cent of GDP, this translates to a very significant total stimulus that compares well with most emerging market economies,” Shah said.

Fiscal stimulus

Nevertheless, the fiscal stimulus could have been much more effective on several counts, according to NCAER.

First, in terms of timing, the enhanced Central spending could have been initiated much earlier. Second, States could have been enabled to increase their borrowing and spending earlier in the year, since they are at the frontline in providing all services, battling the pandemic and also providing income support to those who have lost their livelihoods in the pandemic.

Third, the marginal propensity to consume has declined and the income multiplier has weakened because of the shift in income distribution against low income wage earners and micro household enterprises. To offset this, the change in the composition of expenditure in favour of health services and income support programmes could have been pushed much further. The Pradhan Mantri Gram Sadak Yojana, which combines infrastructure development with income support, would be particularly welcome in this context.

Government borrowing

The massive increase in Central and State government borrowing because of the ballooning fiscal deficit is a major challenge for monetary policy and the financial sector. The RBI has introduced a whole slew of measures to contain the adverse impact of such a large increase in government borrowing on the cost of money and credit flow to the private sector. But its success has been limited. It is unlikely that a fragile, NPA-burdened financial sector can cope with such massive sovereign borrowing. This poses a major risk for macroeconomic stability. Hence financial sector reforms are the most urgent in the large menu of structural reforms, NCAER has said.

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