The Perfect Enemy | What Does the COVID-19 Experience Tell Us about Indian Growth Drivers?
October 4, 2022

What Does the COVID-19 Experience Tell Us about Indian Growth Drivers?

What Does the COVID-19 Experience Tell Us about Indian Growth Drivers?  Economic and Political Weekly

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Parts of this paper were presented at SSS-AIU, Study Group and EGROW Foundation webinars, O P Jindal Finance Global Finance Conclave and Rajagiri Conference on Economics and Finance. Enthusiastic feedback helped improve it. In particular, the author thanks Charan Singh for the invitation to develop one of her op-eds, Arvind Virmani, Amartya Lahiri and an EPW referee for comments. The author would also like to thank Krishnandu Ghosh and Sandipan Saha for research assistance and Shreeja Joy Velu for secretarial assistance. This paper is an updated and abbreviated version of IGIDR WP-2021–025.

In India’s battle with COVID-19, recovery was largely under-predicted and financial sector distress over-predicted on the view that more structural reforms were a prerequisite for growth. Inferences derived from better-than-expected outcomes are that beyond fundamental reforms, sustaining Indian growth requires continued fiscal supply-side action that reduces costs of doing business and inflation, allowing monetary policy to keep real interest rates below growth rates, thus stimulating demand and allowing public debt ratios to fall. External shocks have to be smoothed, while avoiding large domestic policy shocks in order to lower growth volatility and undertaking only feasible complementary reforms.

Acommon phrase used in the analysis of India’s perfor-mance during the COVID-19 period was that “the economy had been under-performing before Covid-19 hit …” Another common view was that the financial sector was stressed and Covid-19 would damage it further, thus reducing monetary transmission and making fiscal stimulus more effective. However, fiscal space was limited. Partly because of these perceptions, when the global pandemic hit, the majority of predictions for the economy were dire (Mundle and Sahu 2021; Sheel 2021). Small enterprises were thought to be in deep trouble with too little help. Higher unemployment without income support would reduce consumption. The recovery was expected to be slow and long-drawn-out, with long-term scarring lowering potential growth. Yet, the experience so far has been very different. This paper argues that the better-than-expected growth recoveries and financial stability imply (i) reforms, especially financial reforms, are adequate; and (ii) appropriate monetary–financial conditions, with supportive supply-side fiscal action, can deliver growth.

The 2021 Nobel Prize for economics was given to economists who used natural experiments to tease out robust inferences. The COVID-19 pandemic and its unexpected outcomes give us an opportunity to identify India’s growth drivers and explanations of growth slowdown that are consistent with the Covid-19 surprises. In macroeconomics, progress comes through a process of “abductive” reasoning, where new facts that do not fit in a framework of reasoning lead to a refining of that framework, so that it is consistent with the facts (Goyal 2017b). For example, stagflation could not be explained in the Keynesian demand-side framework and led to the development of real business-cycle theories that emphasised the supply side.

India did have a growth slowdown through the 2010s. Excessive monetary–fiscal stimulus after the global financial crisis (GFC) led to over-tightening, as inflation was persistent and double deficits widened. Pushing public sector banks (PSBs) to lend for infrastructure had resulted in large non-performing assets (NPAs). When the rest of the world was going through quantitative easing, credit growth crashed in India as monetary–financial conditions tightened sharply. Stabilisation was ignored and the focus was on structural reforms.

As monetary–financial policies became more relaxed in 2019, the economy turned around and began to grow before COVID-19 hit. This is perceptible in high frequency indicators. Monetary–financial conditions became highly accommodative through the COVID-19 period, as the financial sector strengthening was adequate. Fiscal expansion was conservative. Even without a large fiscal impulse to support demand, or major medium-run reforms, recovery was robust after all three waves.1 The government view, as enumerated in economic surveys, is that continuing reforms drove growth (GOI 2020). Many reforms had indeed been carried out, but did not deliver growth until there was a reversal of monetary–financial tightening. A rise in world exports was also a favourable demand shock in 2020. Indian exports rose despite COVID-19 constraints. World exports had risen in 2018 as well, but Indian exports had continued to stagnate when Indian monetary–financial conditions were tight.

It follows that a coordinated monetary–financial–fiscal stance can support India’s growth. Countercyclical macroeconomic policy is essential. Reforms, as conventionally understood, are not a prerequisite for higher growth, but continuous supply-side improvements through feasible reform that reduces the cost of doing business—and therefore inflation—can sustain growth. Also, external shocks have to be smoothed and large domestic shocks avoided to lower volatility. This allows monetary and fiscal policy coordination, attuned to Indian conditions, to deliver the required balance between supply and demand.

Growth Predictions and Performance

The strength of the recovery in 2020, after a strict lockdown, and in 2021 after a severe second wave, surprised many. Through 2020, pessimistic growth predictions regularly had to be revised upwards. The average predictions of 30 professional forecasters made over September to March 2020 for growth in the fiscal year 2020 (FY20) became less negative—from -9.1 to -7.5—and their predictions for FY21 rose from 7.4 to 11 (Table 1).2 Under-predictions dominated because of the perception that India was already doing badly pre-Covid-19, making medium-run structural changes prerequisites for growth to recover. Since the financial sector was thought to have serious dysfunctionalities that reduced monetary transmission, the limited fiscal stimulus was also seen as a serious constraint.

The Delta variant economic shock was limited to Q1 2021 with strong recovery in July. Job loss was smaller and more transient in the second wave and was barely present in the third wave (CMIE nd). Data coming in showed some recovery in consumption, more in investment, while government expenditure was uneven across quarters (Tables 2a and 2b). There were signs of the long-awaited uptick in investment. Export growth was robust and even overtook 2019 values. Growth was back to positive values by Q3 2020–21, after two quarters of negative growth, following the initial lockdown. Quarter 1 of 2021–22, in which the impact of the COVID-19
second wave was concentrated, showed large positive year-on-year growth because of the base effect (Table 2a), but quarter on quarter growth was negative (Table 2b). Both were strongly positive in Q2, however. Q3 slowed somewhat in a post-festival effect and with the beginning of the third wave of the pandemic. Annual growth for 2020–21 came in at -6.6% despite growth being -23.8% in Q1. Median growth expectations for 2021–22 were 7%–9%. Recoveries were strong between waves and successive waves had lower economic impact, as lockdowns became localised. High second-year growth was not just because of the dip. Many countries had steeper fall in 2020–21 but a shallower recovery despite more government spending (for example, Mexico -8.2 and 5.3; Spain -10.8 and 4.9; and France -8 and 6.7 [IMF 2022].)

If the view that there are fundamental constraints to growth is correct, strong recoveries are puzzling, since the constraints would not have changed. Monetary–financial conditions had softened since 2019. This was taken further after COVID-19 hit and seems to have delivered.

The softening of these conditions in early 2019 had led to a year-end growth revival, visible in many high-frequency
indicators (Figure 1). Due to the negative impact of Covid-19 in March 2020, yearly or quarterly growth rates decelerated, which suggest the economy was in continuous decline even before the COVID-19 pandemic. If a softening of monetary–
financial conditions contributed to a growth turnaround visible in high-frequency data in the months before Covid-19 hit, it is likely to have contributed to post-COVID-19 recoveries.

Financial Sector Predictions

Given the perceptions that gross non-performing assets (GNPAs), especially in PSBs, were high, predictions were particularly gloomy for the Indian financial sector. It was seen as fragile and expected to add to the stress on the economy.

The baseline projection of the widely quoted Reserve Bank of India (RBI) financial stability report released in July 2020 expected a rise in GNPA ratio to 12.5 in 2021 from 8.5 but the ratio actually fell to 7.5 (Table 3). Moratoria and restructuring helped, but repayments were more than expected, collection efficiencies were in the range of nineties and restructuring was limited (Lele 2021).3 Tables 4 and 5 show that large capital buffers were built. The capital held relative to risk weighted assets ratio (CRAR) actually rose in this period. These were adequate to absorb the limited deterioration in asset quality that occurred largely in private banks. Again, the RBI projections underestimated the increase in capital buffers (Table 4). Table 5 shows that GNPA and net non-performing assets fell, while provisions and capital ratios increased for most banks. Some stress in retail loans after the second wave proved transitory due to a good recovery.

These perceptions were widely shared. For example, Moody’s ratings upgrade for India in October 2021 explicitly said the
financial sector had surprised them on the upside (
Verma 2021; Ahmed and Kumar 2021).

Forecast errors were especially high for PSBs. One reason for their outperformance is that generous provisioning had reduced NNPAs to low single digits even before the COVID-19 pandemic, although the GNPA figure, which tended to be the one quoted, was still high. Table 5 reports the two figures as 4 and 10.8, respectively in March 2020. GNPAs were still high because of delays in the Indian bankruptcy process, but awards were coming in and these added to profits (CRISIL 2019). High provisioning was possible because recapitalisation was adequate after the Indian bankruptcy code (IBC) was passed in 2016. The government had waited to put more money into PSBs until large private creditors could be bailed in. The IBC did this, by making it possible for them to lose their assets (Rao 2022).

Regulatory relief was time-barred in line with reforms. The latter assured risk-based lending and adequate provisioning. The PSBs were also lending more to retail and to micro, small and medium enterprises (MSMEs). Although NPAs under the Mudra Yojana for MSMEs were at 11.98% at end March 2021, loan sizes were small and government credit warranties for MSMEs were a healthier way of subsidising small firms. These limited the impact on books of banks, reducing their risk-aversion for such loans. It is better that subsidies are directly borne by the government, instead of being forced on a commercial sector that then fails.

Although low demand from large firms, as corporates de-leveraged, as well as continuing risk-aversion of banks kept growth of bank credit low, the share of non-bank financing of the commercial sector rose to 70.5% in 2020–21 compared to 47.7% in 2018–19 (Table 6, p 54).4 It remained higher at 56.6% in 2021–22 despite some recovery of bank credit share. Risk-based retail loans grew in double digits. Banks were also participating in the corporate bond market.

Aggregate financial flows to the commercial sector did rise. Even in 2020–21 they were at 72.3 (as % of 2018–19 levels), higher than 65.3 in pre-pandemic 2019–20. Higher liquidity played a role in enabling this. Commercial papers and NBFCs reversed a fall in share. Although credit growth to industry in October 2021 was only 4%, that to medium industries was 48.6%. Some sectors did well. Credit to micro and small enterprises grew to 11.9%, and credit for consumer durables grew at 44% (RBI 2021b). The credit growth in April 2021 to March 2022 over the same period in the previous year was 129.8% (Table 6). Year-on-year bank credit growth reached 11%.

Financial flows rose despite a shrinking in the share of foreign sources in the first year of the pandemic, and more stable foreign direct investment dominated.

Reforms included more deepening and diversity in financial markets, as well as creation of institutions like the IBC, a development finance institute (DFI) and a bad bank. These are essential for long-term financing that avoids the discretion, control and possibly poor decisions of governments while using their ability to borrow at lower costs and de-risk long-term infrastructure projects. The new DFI can help leverage government funds to attract global funds available under the net zero climate change initiative. Diversity helps avoid the volatility and short-term view of markets while using their discipline and autonomy. It is necessary to serve an economy as varied as India where some use sophisticated derivatives and others are opening a bank account for the first time—as in the Jan Dhan Yojana of the PSBs.

Corporate governance was generally strengthened, shell companies eliminated, databases built and other anti-corruption measures taken. Limits were placed on large exposures (Balasubramaninan 2014; Goyal [forthcoming]). Better governance is a prerequisite for a healthy corporate bond market to develop.

Thus financial reforms had made progress in delivering better governance, regulation, lending practices and stronger balance sheets, as well as more diversity. The latter improves stability while creating more options for development and private financing.

Reversing Tight Financial Conditions

In the post-reform period, government debt and interest payments were relatively high. The corporate bond market did not develop adequately. Therefore, financing infrastructure was a problem. Pushing infrastructure loans to private parties from PSBs had resulted in large NPAs. Through the 2010s, when credit was increasing worldwide under quantitative easing, the clean-up of banks and firms meant India had tight financial conditions. Corporates were deleveraging.

As seen in Table 7, Indian government had more debt but overall (corporate and household) debt was much lower than in other emerging markets. In 2019, Bank for International Settlements data shows the debt/GDP ratio for the Indian private sector to be 87.2 compared to 147.1 in emerging markets. For the government, however, the respective ratios were 71.9 and 53.6. Emerging markets had the largest rise in corporate debt in this period, and advanced economies, in government debt.5

India was therefore ready to use the financial sector to contribute to the fiscal stimulus. Private leverage was not high unlike in most other countries. Although in advanced economies quantitative easing was excessive, since it added to that of the last decade, in India, financial conditions were due for a turnaround after the drought of the 2010s. However the rise in public debt had to be moderate, since it exceeded its peers. Even so, in 2020, the rise in aggregate debt in India was only half that of the emerging markets (Table 7), and relative caution continued.

Long-term Scarring

How robust are growth recoveries? There are signs of scarring in the education of the digitally excluded, in women’s work and in MSMEs all over the world. But in advanced economies there is fear of zombification as excessive support locked
resources into non-competitive firms.

In India, which could not afford 30% of the GDP as a fiscal deficit, support was too little. The informal sector was thought to be badly hit and this contributed to predictions of weak recovery. Since data on the informal sector is only available with long lags, initial growth estimates based on past benchmarks were regarded as overestimates that would be revised down, as current data came in. However, the second advance GDP estimate of the Central Statistics Office (CSO), based on better data, raised growth in 2020–21 to -6.6% from -7.3% suggesting that the impact on MSMEs was less severe compared to expectations (MOSPI 2022). Even so, we have to wait for more data.6

There are alleviating factors, however. MSMEs had to substitute towards new opportunities that enhanced innate resilience. There was faster adoption of digital and other innovations. Up to 7% government supported bank finance that get bank loans was based on assessment of long-term survival. Smaller firms had traditionally drawn on informal sources of finance that were active under easier liquidity conditions. Gold loans boomed. In 2015, 96% of smaller firms were owned by one household suggesting they could remain active despite lockdowns, through work from home
(NSSO 2017).7

India’s very low women labour force participation may rise as the COVID-19 experience makes “work from home” more acceptable for women and their employers. Apart from government programmes, a vibrant NGO–CSR sector supported the deprived. Faster-than-expected recoveries, pent-up demand, revenge consumption and forced innovations helped contact industries recoup.

The lockdown unemployment peak proved transient and unemployment was lower in the second wave (CMIE nd). Even so, low productivity informal employment dominates in the Indian economy, and labour force participation rates are low. However, faster digitisation following the COVID-19 pandemic may enhance structural changes taking place.8

There are multiple entry points in labour markets. Expanding education, health and urban services in Tier 3 towns and a sharp rise in entrepreneurship are creating many jobs. New Indian firms are becoming unicorns. The India Stack and low- cost payments infrastructure highway such as Unified Payments Interface (UPI) have enabled many digital innovations, allowing opportunities in web-based employment for the young. Social media influencers are earning large sums and creating jobs, even in small towns (Chaturvedi and Laghate 2022). The possibility of moving up according to skills creates quality ladders. The less skilled can, with minimal training, get jobs in retail, delivery and other urban services. Supply chain diversification together with incentives from Production Linked Incentive schemes may finally allow India to create jobs in labour-intensive manufacturing.

To the extent that formalisation was taking place before the COVID-19 pandemic, its negative impact on the informal sector would be lower. Large firms did gain more, but some small firms may have grown. It remains to be seen how these opposing effects play out.

Decade of Underperformance

If structural impediments were not severe, then why did India’s growth become slow in the 2010s? India was not alone in this. In the past decade, emerging markets, as a group, grew more slowly under many global shocks. For 10 major emerging markets, index of industrial production growth was 4.3 preceding the GFC (2000–08) and 1.3 after the GFC (2009–17) (Goyal et al 2021). The years 2011, 2013, 2015 were actually larger shocks for emerging markets than 2008 itself. Not enough was done to moderate spillovers and the consequences of global risk variables on emerging markets.9

Second, India had the added disadvantage of PSBs passing through a severe NPA crisis after they were nudged to support the infrastructure push of the late 2000s. Deposits are for a short term compared to an infrastructure project. Global shocks compounded this basic asset liability mismatch. There were delays in resolution. The RBI conducted an asset quality review even though the government was waiting for the IBC to be passed into law before recapitalising banks. Bank credit fell sharply. Highly geared firms suffered, as rates rose. The NBFCs collapsed without liquidity support. As a result, private sector’s credit growth was the lowest in the world (Table 7). Regulatory policies were also stricter as a reaction against corruption allegations surrounding the growth boom in the 2000s and a number of scams in firms. Critical reforms such as the goods and services tax (GST) had implementation costs.

Monetary, fiscal as well as regulatory tightening overreacted after surplus stimulus following the GFC led to double deficits and vulnerabilities to global quantitative easing and risk variables. There were also food and oil-price shocks. While some reforms were essential, and costs had to be borne, it is never wise for everything to move in one direction.10 Stabilisation, which is needed in India in response to specific shocks that cause macroeconomic volatility, was neglected. Thus, global as well as domestic policy shocks reduced growth. There was a decade-long stagnation in investment.

Growth Drivers

What then are the growth drivers that led to better than expected recoveries, and how can they be sustained? Reversal of the macroeconomic and regulatory tightening was a major driver of the recovery. This did begin in 2019, with a move to more balance and better monetary–fiscal coordination. Policy has to be countercyclical and must smoothen external shocks. Foreign exchange reserves are adequate for this purpose and the absence of full capital account convertibility also gives space to support the domestic cycle if there are outflows during the Fed exit.

Through the decade of slowdown, there were essential reforms in the financial sector, in taxation and in order to reduce corruption. More needs to be done, but focus can now be on feasible reforms that improve the supply side. Foreign advice often emphasises on reform of factors of production such as land and labour as a prerequisite for sustained growth. However, there is political resistance whenever large groups are affected. We have just seen how large domestic shocks contributed to the slowdown. It is necessary to avoid such shocks. Recoveries have been healthy even without land and labour reforms taking place. It follows that such reforms are not a prerequisite for growth. Since they give rise to large political resistance they are better done slowly, quietly, through competition and coordination among states in a federal structure.

Reforms need to be feasible and in line with political economy. It would be fruitful to work with current trends, building on opportunities from technology and innovation in the context of India’s youthful population. The COVID-19 pandemic has intensified opportunities from digital work from home, outsourcing, and supply-chain diversification. To fully harness potential, much work needs to be done on education, skilling, infrastructure, institutions and empowerment to enable more to participate—initiatives are continuing in these areas.

Governance can be improved for delivery. A clear focus on reducing the cost of doing business and enhancing human capacity will deliver better outcomes. Convergence to best practices can be induced for states. This is more than just improving ranking on indices, but requires awareness, dialogue and change in ways of working. Capacity has to be built at the third tier, where quality public services offered can be linked to taxes or user charges. That labour productivity is rising, especially in the informal sector which tends to be more dependent on public services, implies that change is taking place (NSSO 2017).

Fiscal–Monetary Strategy

The structure of pre-reform fiscal policy can be characterised as one of plans plus populism. Low returns from large investments in public sector enterprises were partly responsible for the debt/GDP ratio crossing 70%. Populism meant that despite cost shocks, prices were not allowed to rise. Low or no user charges for many public services resulted in cross subsidies, distortions, and deterioration in quality. However, the large stock of inherited poorly monetised assets can be leveraged to improve efficiencies as well as to restructure government towards supporting human and physical capital formation, which has the maximum spillovers. Asset monetisation also offers opportunities for public–private partnerships, with government de-risking of projects. Tax reform and data-use can increase the tax base. For the really poor, income support through direct benefit transfers reduces leakages and other distortions.

Using the financial sector, for instance, giving credit warranties to support bank loans to small firms, shifts certain spending items below the line. Then current public sector borrowing requirements and crowding out of the private sector is reduced. They do add to debt but need not raise debt ratios to the extent they contribute to raising GDP. Recapitalisation bonds are one example. Credit warranties need not be exercised at all if repayment ability rises with growth. The financial system is ready to be used in the design of stimulus both because it is stronger and because the time is ripe for a reversal of tight monetary and financial conditions that would better utilise it.

Coordination: To the extent continuing improvement in supply conditions reduces costs and inflation, monetary policy can keep nominal interest rates and borrowing costs low.11 India’s post-reform growth has been volatile, but may be less so in
future, since apart from financial sector shocks, oil and food price are also likely to be somewhat less severe, due to changes in productivity in agriculture and in the political economy of oil pricing. The war between Russia and Ukraine is unlikely to change that in the long run.

In the post-COVID-19 world of supply shocks and high government debt, monetary–fiscal coordination has become acceptable in advanced economies, while earlier it was regarded as compromising monetary policy independence. In India, however, coordination normally does better because supply shocks dominate inflation and can be better influenced by state action, while monetary policy has more space to affect demand.

Research shows that monetary transmission to output is eff­ective in Indian conditions, while high debt and interest payments constrain fiscal spending.12 Procedural delays and risk-aversion also adversely affect the latter. The real interest rate together with liquidity affects demand and output. Persistent liquidity deficits leave both the informal and the market sector that do not have access to central bank liquidity, underserved. Then, liquidity hoarding adversely affects payments through the economy. This was the case in the 2010s. Liquidity has to be in sufficient surplus to ensure that shocks such as foreign outflows, currency leakage or rise in government cash balances do not create a durable liquidity deficit.

The government does create demand in excess of its income since it runs a deficit, but overall demand is not in excess, since there is a large working population in transition to higher productivity work, making unemployment high and the supply response elastic, although it is subject to cost-push.13 Persistent second-round effects of supply shocks that raise inflation beyond the tolerance bands require monetary action that is likely to impose output sacrifice.

A flexible inflation targeting regime has to respond to persistent inflation in order to anchor inflation expectations. Following a rule insulates a central bank from political pressures, supporting its independence. Even so, real interest rates can be kept below growth rates while reducing the volatility of both. Falling debt ratios, as growth rates exceed real interest rates in the “snowball effect,” reduce risk premiums and prevent rating agency actions that can raise interest rates in emerging markets. The snowball holds in high growth emerging markets, but is vitiated by volatility in growth and interest rates. Therefore, policy should aim to smoothen both.

Interest rate policy enables appropriate fine-tuning of demand. For example, if there is overheating or persistent inflation, rates can be raised but calibrated to the recovery. Monetary policy can adjust the real interest rate to keep demand a step ahead of supply and sustain growth, as long as the government alleviates some of the supply-side issues that create inflation.14 The resulting gradual rise in spending, if the real interest rate is kept around the natural rate, will be sustainable.

For sustaining higher growth rates, apart from cost reduction, demand has to be high enough to induce investment to rise. In past switches to higher growth paths in India, the marginal propensity to invest rose above the capacity to save (Goyal 2020).

Pre-reform rise in public sector investment drove the process, but was unable to sustain its share, because of the rise in public deficit and debt in the 1980s. At its peak of 12.5% of GDP in 1986–87, its share was half. By 2002–03 it has fallen to 6.4% of GDP. Although this rose to 9.4% of GDP by 2008–09, its share was still less than one-third. There was a need for private investment to rise as well. Post reform, there was a rise in the mid-1990s and mid-2000s. Each time, the jump was halted by supply-side-led inflation, a sharp rise in interest rates, and NPAs.

A more stable and diversified financial sector can finance investment that leads savings. The rising share of foreign direct investment can complement domestic investment. In the past, savings ratios followed a jump in investment, as incomes rose. Therefore current rates need not be a constraint, as long as inflation and real interest rates stay stable. Changes in the composition of savings also make them more available to finance investment. Although household savings have fallen, the share of financial savings in household savings is rising. There is a rise in corporate savings too.

The rise in the share of investment in government expenditure can crowd in private investment, while a low real interest regime raises it further. Together, investment may reach a critical mass. Small, but well-coordinated beginnings that avoid both demand constraint as well as excess demand, can trigger and sustain higher growth. The COVID-19 period has granted experience in handling supply–demand mismatches. The pandemic response illustrates the effective use of the monetary–fiscal strategy discussed, as well as the cautious use of the financial sector in the post-pandemic stimulus.

Pandemic response: The immediate response to the COVID-19 pandemic was monetary stimulus, regulatory relief, moratoria, and restructuring. In the first stage, the government spent on medical facilities, free food and unemployment insurance. Then, it announced warranties through the financial sector. The support through banks went only to illiquid and not to long-term insolvent firms. Reform measures that improved supply conditions, including frontloading infrastructure spending, were continued, making monetary accommodation more feasible. Expenditure on infrastructure also has a higher multiplier.

In 2020, the government was initially accused of under-spending and was told to focus on creating demand. However, when the fiscal deficit ratio was revealed to be 9.5, the debate shifted to the concern about debt and its financing. The demand was to give large protection transfers that the advanced economies gave, but this is unaffordable for a one billion plus population (Sen 2020).

The COVID-19 pandemic facilitated a new type of crisis response for India: not tightening against outflows but easing of monetary stimulus; even a quantitative easing-type expansion of central bank balance sheet, cuts in policy rates, with a limited increase in government deficits. Timely transparent reversal, reforms and medium-term fiscal consolidation capped risk premiums. There was a correct sequencing and combination of demand and supply measures. In advanced economies, over-emphasis on demand led to persistent supply bottlenecks, creating inflation for the rest of the world.


Post-reform growth in India was volatile, but some constraints are easing. After the GFC, macro policy and regulations were too loose; after 2011 they were too tight. There is now a move towards greater balance.

Essential reforms are adequate. Although slow, fundamental reform was undertaken in the financial sector, it had become relatively healthy prior to the COVID-19 shock and in order to preserve this, moratoria, restructuring and liquidity support given were not indefinite. That stimulus did not go overboard underlines the new-found balance in policy. Despite the required rise in deficits, there is a clear path to fiscal consolidation. As monetary financial conditions remained relatively soft, the resource flow to the commercial sector was actually higher in 2020–22 than in the pre-COVID-19 year.

To sustain growth and employment, it is necessary to avoid large policy shocks and implement feasible reforms with continual supply-side improvements. If this, along with inflation targeting, keeps inflation low, while shocks decrease in intensity even as the ability to smooth them rises, volatility in real rates and growth rates can be reduced, keeping growth high.

While appropriate fiscal–monetary–financial policies can be growth drivers, India’s demographic profile gives it a big growth advantage. In an increasingly ageing world, there will be a premium on youth, talent and entrepreneurship.
India has all this in abundance (Goyal 2021). It is this energy that will create 
inclusion largely from empowerment,
given opportunities from technology/innovation, outsourcing, supply chain diversification and basic support such as better infrastructure.


1 While the central fiscal deficit ratio did rise from a targeted 3.8 into double digits, this was largely because of a fall in revenue and and addition of budget food subsidies on budget. Fiscal impulse refers to spending on new programmes in response to COVID-19. The IMF estimated this at 1.6% compared to an emerging market average of 3.1 and advanced economy average of 8%. Even so, there was large countercyclical spending in excess of revenue.

2 There was larger variation in individual forecasts, with the majority predicting large slowdowns in the absence of strong government support. For example, in Sen’s (2020) best-case post-lockdown scenario, with no material rise in government spending, FY20 growth was -12.4% and that in FY21 -8.8%. A few did see a robust revival. For example, in April 2020, Virmani and Bhasin (2020) forecast that 2020–21 GDP growth would be between 0.2% and 3.9% with a likely value of 2.3%. My forecast to a media channel in July 2020, before individual states started imposing restrictions on inter-state movement, ranged between -3% and 1% (Wire 2020).

3 Restructured advances were only 0.9% of funding by March 2021. A committee set up on restructuring, with M V Kamath as chair, had expected restructuring to amount to `10,000 crore but it was less than one-tenth of that.

4 This is the direction modern financial systems are taking. Gorton (2021) shows only 50% of the US business loans originate in the banking system and amount to 10% of the US GDP. In India, the share fell steeply because of corporate de-leveraging and banks preferring retail loans. It is recovering somewhat as business picks up.

5 A debt survey also corroborates this picture (NSO 2021). In 2019, compared to 2013 urban household indebtedness stayed unchanged at 22%, while rural increased from 31.4% to 35%. The average for faster growing and more financially developed southern states was generally above the all-India level.

6 Rating transition matrix from ICRA, CARE showed that 68% of MSMEs they rated stayed in the first category in September 2021. A preliminary RBI study based on Periodic Labour Force Survey (PLFS) data showed a 6% fall in MSME wage share after the first wave but a full recovery after the second wave.

“Proprietary enterprises (that is enterprises owned by a single household) had the highest share (96%) of unincorporated non-agricultural enterprises. Nearly 20% of these were owned by females. Only 2% of enterprises were operated on a partnership basis” (NSSO 2017: Statement 7.0).

8 There is migration to jobs in education and
services the PLFS (2017–18) reported the share of “other services” in usual status female
employment rose from 3% in 1977–78 to 8.9% in 2017–18 in rural areas, and from 26% to 44.4% in urban areas (NSO 2019: 65).

This was short-sighted because a rise in the relative size of emerging markets made protecting them necessary to prevent negative spillovers to advanced economies themselves. Advanced economies’ share of global GDP in purchasing power parity (PPP) terms had fallen from 54% in 2004 to 42.18% in 2021.

10 Virmani (2020) finds evidence of a J curve in the impact of the financial, tax, and anti-corruption reforms imposed in the 2010s. They first cause growth to fall. Then it rises faster. It is, however, not necessary to aggravate a dip with macroeconomic tightening.

11 Reforms such as Gati Shakti, which aims to
reduce the share of logistics in costs from 13% to 10% by correcting the excessive use of costly and polluting road transport, can keep conditions conducive. Improvement in agricultural infrastructure such as better storage, can
reduce price volatility in specific commodities.

12 Goyal and Arora (2016) show the interest elasticity of aggregate demand (-0.21) in a semi-structural estimation with gap variables is as high as in advanced economies. This is intuitive because consumer durable and housing loan demand is interest elastic and induces
demand for working capital and investment funds in time. Goyal and Agarwal (2020) show liquidity aids rates transmission in India.

13 Goyal (2011; 2017a) developed a macroeconomic model demonstrating this. The first paper derives it from a general equilibrium foundation, the second from a policy perspective. I thank Arvind Virmani for suggesting it should be given an appropriate label. Since it analyses demand and supply simultaneously in a small emerging open market, EMDS (emerging market demand supply) may be suitable.

14 Goyal (2018) demonstrates that in Indian conditions delegation to a conservative fiscal and pro-growth monetary authority gives the best results.


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