In continuation of the first piece published on March 7, where we discussed the role of consumption and investment in India’s post-pandemic economic recovery, here we look at the roles that external demand and the fiscal side may have played.
We plot the share of exports in GDP with the GDP growth rate in Chart 1A, which shows that the growth of exports (perhaps as a result of pent-up global demand) has contributed to the overall growth of the economy. The level of exports is dependent on the income of the countries to which India exports. So, by virtue of being an exogenous factor, they can play a balancing role, particularly during domestic slowdowns, provided the global economy itself is also not slowing down. Because if it does, this buoyancy of exports may not remain in the medium run. Chart 1B shows that fiscal spending has also helped, even though the magnitude of its contribution in revival, which we saw in the first part, was not as significant as the other factors.
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Let us focus on these two variables starting with the external sector. In the context of exports, it is often argued that the depreciation of the rupee helps since Indian goods become cheaper for the rest of the world even as imports become more expensive. In this context, the outflow of footloose capital as has happened in the recent past (resulting from the rise in Fed rate) may not be all that bad since it depreciates our currency. But does this really hold in the Indian case? Chart 2 shows that as the rupee lost value in real terms (what is called the real effective exchange rate), India’s trade balance deteriorated instead of improving.
So, despite a fall in the real value of the rupee, India lost to competitors (in the net). This is not as surprising as it may seem because, as the global economy slows, our exports slow down irrespective of whether our goods become cheaper. On the other hand, our imports may continue to rise depending on how our economy grows. In other words, the loss of the rupee is at best a sideshow in the Indian export-import story. Other studies have shown that this has been the case even during the heydays of Indian high growth of the 2000s. We should not draw solace from a falling rupee.
That brings us to the last, but not the least (particularly at this juncture), factor — fiscal demand. Fiscal policy is as much about redistribution as about demand generation. Chart 3 shows that fiscal expenditure has been made easy by buoyant tax revenues so the two have moved in tandem.
There are two issues here. One, in itself, a regime of tax-financed government expenditure is not a bad idea provided these taxes don’t disproportionately burden the poor and the marginalised. Because if they do, it would be like providing an employment guarantee but financing it by taxing the same person more. Unfortunately, India has one of the most regressive tax systems (the ratio of indirect to direct taxes) among the G20 countries. This warped composition of taxes has to change if we are to move forward both in addressing demand and distribution. Two, for the sustainability of this economic revival, one needs to have the flexibility where government expenditure does not remain tethered to the tax revenue since in the event of a reversal of economic fortunes, the tax revenues will nosedive as well. An untethered fiscal expenditure in such a situation will come in handy both in the short and medium term to help the economy stay afloat and weather the storm.
Rohit Azad and Indranil Chowdhury teach Economics at JNU and PGDAV College, Delhi University, respectively
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Source: Ministry of Statistics and Programme Implementation (MOSPI), RBI, U.S. Federal Reserve
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