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India Nees Demand Side Stimulus to Turn Its Economy Around

The COVID-19 pandemic has taken its toll on global growth and has helped contract India’s economy. The Reserve Bank of India (RBI) expects the Indian economy to contract in the current fiscal year. The Indian government place heavy restrictions on movement in April and began to lift some of those restrictions in May. While it appears that liquidity is on the rise, demand has slumped and will need an influx of investment and spending to help further buy Indian shares, which are tightly tied to Indian economic growth.

Before the Pandemic Growth was Decellerating

Before the Pandemic forced the Indian government to demand a statewide quarantine, the Indian economy was beginning to decelerate. Indian GDP growth has been decelerating for 3-straight years, due to the lack of demand. GDP was 8.3% in 2016-17. It fell to 7% in 2017-18, 6.1% in 2018-19 and 4.2% in 2019-20. The issue appears to be a function of demand as opposed to liquidity. To assist, the Indian government attempted to provide a liquidity stimulus that helps prevent banking issues related to money in the economy. In September 2019, the government slashed corporate taxes. This was expected to promote investment and demand and boost economic growth. Additionally, the RBI has mostly either reduced interest rates or kept them stable. This was expected to reduce the cost of capital and promote investment. Unfortunately, investment was falling before the unset of the pandemic and it appears to be continuing to fall. 

Meanwhile, consumer sentiment is faltering, dragging down demand as the quarantine has weighed on consumer demand. RBI’s consumer confidence surveys show that current perceptions of income and non-essential spending have collapsed. This lack of demand has not gone unnoticed. The RBI’s Monetary Policy Committee pointed to weak demand as a problem in its resolutions last year. Unfortunately, the central bank only has one tool to deal with the lack of demand which is interest rate cuts which do not boost demand.

Fiscal Stimulus is Non-Existent

The government is now pointing to the RBI, which in turn is pointing back to the government. In the US, the central bank and the government are working hand in hand. The Federal Reserve cut rates immediately to zero and embarked on a bond purchase program that was uncapped. Additionally, congress let louse a multi-trillion dollar fiscal stimulus policy to help spur demand. Following the economic crisis in the wake of the COVID-19 pandemic, the US Congress enacted new legislation providing a fiscal stimulus. The fiscal deficit in the US is estimated to increase from $1 trillion to $3.7 trillion in 2020, which is approximately 13% of GDP. India’s fiscal deficit in 2019-20 stood 3.8% of GDP. 

The Bottom Line

The underlying problem is that the Modi Government does not seem to want to take on debt to drive demand. The RBI has done what it initially can, but they will need fiscal stimulus to lead demand higher. They can cut rates to zero and start purchasing assets to buoy liquidity, but this will not help buoy demand. While the share price of the Indian stock market has increased and rebounded, it has not helped consumer sentiment rise, which will be needed to help the Indian economy recover. 

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