How India can strengthen its economic resilience against global and domestic shocks

Global economic slowdowns and crude oil shocks

Since 1950, the world economy has experienced four major recessions in 1975, 1982, 1991, and 2009. These recessions were highly synchronized across countries/country groups. In the first three instances, growth in output slowed down but remained positive while in 2009, it contracted. 

Average world growth in these four slowdown episodes was only 0.3% while average growth in non-recession years was 3.9%, indicating an average difference of 3.6% points (Table 1).

In major economic slowdowns, often a common factor has been shocks emanating from global crude price upsurges. Being a large importer of crude oil, India has remained vulnerable to global crude price shocks. Over the long period from FY1970 to FY2022, crude oil prices that were close to less than US$2/bbl. prior to FY72 kept rising with an asymmetric cyclicality in terms of amplitude and duration of the upward and downward phases. Notable years of major price episodes include FY1979 price surge due to Iranian revolution, the long period of gradual price increase during FY01 to FY09, the price slump following the 2008 global economic and financial crisis, period of global crude prices exceeding US$100/bbl. during FY11 to FY14, the price slump in FY21 due to the COVID-19 impact, and the current price spike due to global geopolitical conflict.

At present, along with the crude price upsurge, there are additional supply chains disruptions which cover five major dimensions namely, (1) sources of raw materials, (2) sources of intermediate products, (3) sources of final outputs, (4) disruptions in trade and transport routes, and (5) disruptions of financial settlement architecture.

Unanticipated pandemics and epidemics

Health related global crises in terms of pandemics and epidemics lead to large-scale human suffering and loss of lives besides having a significant disruptive economic impact. Some instances of major economic losses have been quantified in various studies. In a briefing submitted to the European Parliament in 2020, it was stated that the total value of losses incurred by a severe global influenza pandemic, such as the 1918 pandemic, could reach about US$500 billion per year, about 0.6% of global income[2] . With respect to India, the RBI[3]  recently estimated the output loss due to COVID-19 over the three years from FY21 to FY23 at INR52.6 lakh crore, that is, 7.4% of the corresponding estimated nominal GDP.

Climate change and natural disasters

Natural disasters occur with considerable frequency covering individual countries or groups of countries. Many of these disasters have recently been the outcome of the ongoing climate change. A 2018 UN Report covering six major disasters namely, earthquake, earthquake and tsunami, storm, extreme temperature, flood, and drought estimated the direct economic losses during the period 1998 to 2017 at US$2,908 billion, of which climate-related disasters accounted for a share of 77%. India’s estimated loss at US$79.5 billion was the fourth largest. The World Bank has also calculated the average per annum cost of natural disasters at nearly US$520 billion, with disasters pushing 26 million people into poverty every year. Domestically, India has remained vulnerable to frequently occurring natural disasters. Major natural disaster episodes in recent history include floods in Kerala in 2018, and in Uttarakhand and Kashmir in 2013, a tsunami in 2004, an earthquake in 2001 in Gujarat, and a super cyclone in Odisha in 1999. 

Country-differentiated aging of populations

Differentiated aging profiles of countries during the 21st century have significant economic implications. During this century, large countries such as India are witnessing a surge in their working age population to total population ratio. They are characterized by a high growth potential with low dependency ratios and high savings rates. On the other hand, many countries including China, the US, France, Germany, Italy and Japan, have already started aging. India’s population, although presently young with a median age of 27.3 years (2020), starts to age rapidly and by 2060, its median age would have crossed 40 years. Thus, the four decades from 2020 to 2060 should be considered as the golden period for India’s growth potential.

Domestic agricultural and non-agricultural cycles

Among the India-specific crises, a frequently occurring crisis relates to agriculture, which is periodically affected by floods and droughts. Despite cumulated investment in irrigation across India, agriculture remains heavily dependent on monsoon and therefore, the cycles that get generated linked to the cyclicality of the rainfall relative to its long period average. The periodicity of the agricultural cycle in India over the last 70 years is close to three years while that of the non-agricultural cycle is close to six years.

Fiscal and external sector imbalances: sustainability issues

India’s debt-GDP ratio is recognized to have reached levels that are well above sustainability levels. The combined debt-GDP ratio has increased from a level of close to 50% of GDP in the early 1980s to close to 90% of GDP in the COVID-19 year of FY21. The latest amendment to the central government’s Fiscal Responsibility and Budget Management Act (FRBMA) in 2018 had specified sustainable levels of combined and central debt-GDP ratios at 60% and 40% of GDP respectively and that for states at 20% of GDP. At the end of FY23, the combined debt to GDP ratio is estimated to be 80.5%, nearly 20% points above the FRBMA target.

A similar sustainability issue arises in the context of external debt and current account deficit. From1991 to 1998, government’s share in external debt was higher than that of the non-government sector. At present, total external debt relative to GDP is nearly 20% (2022). The volume of external debt poses a different kind of economic problem, particularly if the share of exports is also limited. India’s share of exports in nominal terms has fallen from an average of 23% during FY07 to FY15 to 19.5% during FY16 to FY22. The average contribution of net exports to real GDP growth has also remained small and negative at (-)0.3% points during FY01 to FY22.

Major upheavals are also occurring in capital flows affecting India’s current and capital account balances, which have an impact on domestic inflation and current account sustainability. These trends have been accelerated because of high CPI inflation rates in many of the developed countries, including the US, the UK and many EU countries.

Domestic inflation

Chart 1 shows that from FY1980 to FY2000, CPI inflation as measured by CPI Industrial workers (general index) averaged 9.3%. This fell to 6.5% during FY01 to FY12. The new CPI inflation series was introduced in 2012. The average CPI inflation during FY13 to FY22 has been 5.9%. High average CPI levels as well as volatility around it are major concerns for not only households but also policymakers. 

Dealing with global economic crises and crude oil shocks

Historically, both fiscal and monetary instruments have been used to address economic crises with global roots. In India, their effective coordination can be improved by setting up a mechanism for coordinated action under the guidance of an overarching supervisory mechanism such as a Fiscal and Monetary Policy Council so that both the growth and inflation objectives are tackled in a coordinated way.

Given the repetitive nature of global crude oil price shock, it may be useful to revive the idea of an ‘Oil Price Stabilization Fund’. The Stabilization Fund should be used such that the price signals are not necessarily fully blocked but the extent of their volatility is reduced. This would allow economic agents to start adjusting to the price signals while partially mitigating the excessive adverse economic impact of large cyclical movements.

The Aatmanirbhar Bharat strategy with an increased focus on complex products and strategic sectors should facilitate a stable growth path for India relatively sheltered from global economic shocks. Some examples of complex products include robots, drones, self-driven vehicles, satellites and rockets, high-definition cameras, telescopes, microscopes, aircraft, 3D printing of goods and buildings, financial derivatives, research and designing of semiconductors, artificial intelligence, and Internet of Things 

Prior preparation for epidemics and pandemics

Building infrastructure, including dual use infrastructure meant to serve both peace time requirements and crisis related emergencies for coping with unanticipated exogenous disasters is critical for this purpose. These should include infrastructure to cope with pandemics, chemical, biological and nuclear emergencies, and global natural disasters such as tsunamis.

India’s health sector infrastructure has remained deficient relative to global benchmarks due to under-investment and under-prioritization over a long period. Investing in expanding health sector infrastructure is justifiable because of its salient inter-linkages with other sectors of the economy. This will prepare India to deal with any future epidemics and pandemics.

Coping with climate change and natural disasters

The Disaster Management Act 2005 envisaged the constitution of two types of funds, one for disaster response and the other for mitigation which are to be set up at the national, state and district levels. The Disaster Response Funds have been set up at all levels in most states but the disaster mitigation funds have not been set up. It is time to activate these funds and undertake planning and strategies of intervention for disaster mitigation. It may be best to earmark a certain portion of central and state budgets for disaster mitigation funds. 

India may continue to pursue its existing initiatives toward the greening of energy at an accelerated pace. These include the Green Grids Initiative (GGI) and the One Sun One World One Grid (OSOWOG). The erstwhile coal cess may also be resumed according to the original objective so that the environmental impact of coal mining can be mitigated in the coal rich states.

Optimizing demographic dividend: budgetary reprioritization favouring education and health

As discussed earlier, India is expected to become the largest provider of human resources in the world when populations in many advanced countries would be aging. The rising working age persons need to be productively employed requiring higher budgetary allocations for education and health. In this regard, it is best to follow global norms of budgetary allocation for these sectors and set up dynamic targets to reach global norms within a specified period, taking full advantage of the currently unfolding window of demographic dividend for India.

Dealing with economic cycles: flexibility in fiscal deficit targets and stabilization funds

Existing mechanisms for dealing with economic cyclicality, whether relating to agriculture or non-agriculture, include flexibility in fiscal deficit targets as embedded in GoI’s FRBMA and mechanisms of buffer stocks and price controls with respect to agriculture. There is a need to revise GoI’s 2018 FRBMA to provide for higher flexibility in fiscal deficit to GDP ratios, along with more realistic conditions permitting such departures. These mechanisms may be supplemented by setting up central and state stabilization funds. The latter would provide an active role for the state governments also to play a countercyclical role, particularly in respect of agricultural cycles and in selected instances even in respect of non-agricultural cycles.

Dealing with fiscal and external sector imbalances

GoI’s FRBMA, as amended in 2018 may be reviewed with a view to examining whether there is a need to: a) bringing back revenue account balance as a target, b) need for asymmetric targets for debt and fiscal deficits for the GoI and states and c) reconsideration of magnitude of departure of the level of fiscal deficit as percentage of GDP from the sustainability norms and the conditions under which this may be permitted. There is also a need to set up an institutional mechanism, such as a Fiscal Council, to oversee the working of the FRLs at the central and the state levels. The FRBM Review Committee of 2018 had also recommended setting up of a Fiscal Council. 

As part of India’s medium term growth strategy, it would be useful to acknowledge that for some more years, a current account deficit may be acceptable if it is financed largely by FDI inflows as long as the current account deficit as a percentage of GDP remains sustainable. The GoI may specify a sustainable level of current account deficit relative to GDP target. India continues to carry a significant volume of foreign exchange reserves and it would be useful to ensure that these reserves are managed in a way to provide a reasonable return on them in terms of foreign exchange.

Coping with price instability: Monetary Policy Framework (MPC)

Monetary policy in India has evolved from a multiple indicator approach and a focus on WPI inflation to a regime of flexible inflation targeting and focus on CPI inflation. In February 2015, MPC was agreed upon between the GoI and the RBI. CPI inflation target for FY17 and beyond was set at 4% with a tolerance range of +/-2%, implying an overall CPI inflation range of 2% to 6%. This target is to be reviewed once every five years. As per the Monetary Policy Statement dated 7 April 2021, the GoI retained these targets for a period of another five years. 

India has followed the example of developed countries to focus on inflation targeting for its MPC. It may be useful for the MPC to coordinate with GoI regarding growth objectives and maintaining sustainable current account deficit, along with exchange rate stability.