From V-Shaped to K-Shaped, Understanding the Alphabet Soup of Projected Indian Growth Recovery

The RBI governor has warned of potentially tougher and gradual recovery, not quite endorsing the optimistic projections put out regularly by the chief economic adviser.

Like the vastly differing versions coming from various arms of the government on the Line of Actual Control (LAC) situation, the Indian economy too has lent itself to multiple interpretations within the system.

Yesterday, Reserve Bank of India governor Shaktikanta Das, in his reading of the economy, clearly suggested the economy was tapering off after a brief uptick in June and July.

Consequently, he didn’t quite endorse the chief economic advisor’s assertion last week that a V-shaped recovery was likely after nearly a quarter of India’s GDP shrunk in April-June. The RBI governor seems to be hinting at a W-shaped recovery, which essentially means a short uptick and then another leg down before a full recovery possibly at the end of 2021-22.

Most corporate heads are inclined to go with the RBI governor’s alphabet (W) as the likely shape of recovery.

Samir Arora, a well-known hedge fund manager in Singapore who runs an India-dedicated fund, has invented a K-shaped recovery for India. Essentially this means that post-COVID-19, some segments of the economy may do very well (like technology, pharma and non-discretionary consumer goods) while many others (real estate, tourism hotels, airlines) will continue to languish for a longer period.

And some also predict a U-shaped recovery with a wider base. Clearly the economy is mired in a sort of alphabet soup and no one really knows what shape it will take in the next one or two years.

The RBI governor has also cautioned that the recovery is likely to be gradual as “efforts to fully reopen the economy are confronted with rising infections”.

RBI governor Shaktikanta Das. Photo: Reuters/Danish Siddiqui

In the meanwhile, most reputed private research organisations are forecasting on average 10% plus overall shrinkage in GDP for 2020-21. Just 1% of GDP decline means about Rs 2 lakh crore of reduced national income. A ten percentage point reduction would imply shrinkage of income by Rs 20 lakh crore for 2020-21. And mind you, this is a conservative estimate. Well-known economist Pronab Sen has predicted a 14% decline in GDP.

So it is certain that there will be a new phase of demand recession next year after incomes shrink so much and the government fails to significantly fill the gap with a direct fiscal stimulus.

The impact of all this on employment will be severe. As it is, the traditional methodology of calculating unemployment post-COVID-19 cannot be the same as before, simply because surveys show over a third of the employed not receiving salaries and another one third receiving only 50%. They are technically shown as employed but actually they are poised to lose income permanently.

The Centre has been hinting at a new fiscal stimulus package to boost the momentum of the economy in terms of increasing aggregate demand. The chief economic advisor said the Centre was keeping its powder dry and would intervene at the right time. One hopes the government realises that when the patient is already in the ICU, delaying delivery of the necessary medicines can be very harmful.

Also Read: COVID-19 and Employment: Why the Definition of Gig Workers Matters More Than You Think

Lessons from the Great Depression

If this is recognised as the worst economic recession since the Great Depression, some lessons could be drawn from the mistakes which deepened the depression in the US between 1930 and 1933.

Economists point out that the one big mistake made when the big recession set in was contractionary fiscal policy, which did not raise aggregate demand in the economy, leading to a 30-35% fall in industrial output.

Of course, the US also kept interest rates high to strictly adhere to the policy dictated by gold standards. That problem doesn’t exist in the current situation as globally, liquidity has been considerably eased.

However, given the nature of economic contraction and subsequent loss of jobs and incomes, a second round of demand compression is clearly coming after supply-side normalises.

The other mishap during the Great Recession in the US, which caused a downward spiral, was the inherent weaknesses in banks. At least 20% of the banks had lost all net worth and shut down by 1932 due to the deepening recession. The Indian financial system is also showing a lot of weakness in terms of the potential for net worth erosion as the RBI hints at post-COVID-19 potential NPAs at 15% of outstanding credit. We will not know the real situation until the moratorium and the proposed 2-year loan restructuring period ends.

A man wearing a face mask sits near closed shops, during the COVID-19 lockdown. Photo: PTI

So on at least two counts – lack of adequate government intervention to raise aggregate demand and the hidden weakness in the banking system – India has vulnerabilities similar to those seen in the initial phase of the Great Recession in the US.

There are some lessons to be learnt there. Lastly, another added risk for India is that it is trying to decouple from China at the same time, thus discouraging future trade and investment possibilities. By doing so, we are preparing not to take the benefit of the only substantial positive contributor to world GDP in 2020-21. This could not only delay India’s economic recovery but add to the risks already mentioned above.