The Covid-19 shock: Learnings from the past, addressing the present - I

  • Blog Post Date 05 June, 2020
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Pronab Sen

Chair, Standing Committee on Statistics

The Covid-19 pandemic and the containment measures adopted to check the spread of the disease, have caused an unprecedented economic crisis in India as well as the rest of the world. Further, India is experiencing a massive humanitarian crisis, exemplified by the scale of reverse migration that is in progress. There is an urgent need for the government to implement policies designed to mitigate the economic damage, and alleviate the suffering of the most vulnerable. In a five-part series, Dr Pronab Sen briefly reviews the current status, and deliberates on what needs to be done, and where we are likely to be in the future.

In the first part of the series, Dr Sen discusses the performance of the Indian economy during the last two major economic shocks – Global Financial crisis in 2008, and demonetisation-cum-GST in 2016-17 – and draws lessons for the current crisis.

There is general agreement that SARS-CoV-2 (that causes Covid-19) has wreaked havoc on the Indian economy, as it has on practically every country in the world. While this is true up to a point, the real story is that the economic damage actually has very little to do with the pandemic itself, and is mainly the consequence of policy responses adopted by various governments to contain and ‘flatten’ the spread of the disease. It would thus be logical to assume that the longer and more rigorous the containment measures, the greater would be the economic damage.

Now here is a curious fact – while everybody also agrees that India has implemented the most comprehensive and draconian lockdown in the world,1 almost all projections for economic growth in 2020-21 place India right up there among the best performing countries in the world. These projections – made by diverse institutions such as the World Bank, IMF (International Monetary Fund), rating agencies, investment banks, etc. – by and large expect India to record positive (albeit small) growth as against a -3% or worse projection for the world as a whole. What makes it even more curious is that while every other country has announced large government interventions to address the economic disruption, the Indian government has not done anything of that kind.

How is this possible? Does India have an inherent resilience that enables it to bounce back strongly from serious setbacks? Or is it that the Indian government is believed to have sagacity and competence greater than the others and that it will do the right thing at the right time? These are burning questions, which demand some reflection.

On the other hand, everybody also agrees that India is experiencing a massive humanitarian crisis, exemplified by the scale of reverse migration that has been and continues to be in progress. Scenes of thousands, if not millions, of migrant labour, often along with their families, trying to go back to their villages any way they can, even walking hundreds of kilometres, are heart-rending. Such scenes have not been seen in the country since the famine of 1965-66, if even then and nowhere near these numbers. The union government continues to remain unmoved, vacillating between insisting on people being restricted to where they are and providing trains to take them home (on payment of course).  Surely a humanitarian crisis of this magnitude deserves a commensurate response; but how much, and for how long?

Consequently, the economic damage is also likely to be very high unless the government simultaneously implements policy measures designed to mitigate the extent of damage. Too much time has already passed without any meaningful policy measures, and much damage may have already happened. The objective of this analysis is to briefly review the current status, and deliberate on what needs to be done, and where we are likely to be in the future.

It appears from close reading that much of the optimism about India’s resilience stems from the country’s performance during the last two major economic shocks – the Global Financial Crisis (2008) and demonetisation-cum-GST (Goods and Services Tax) (2016-17). In both cases the country recovered rapidly; and, in the case of demonetisation, did not seem to suffer at all initially as per the official national income estimates, but this was illusory. However, circumstances were very different then, and it is important that we draw the right lessons rather than take the outcomes at face value.

The Global Financial Crisis

As far as the financial crisis is concerned, which brought the global financial system to its knees, India was spared from the main contagion largely because our financial system was not particularly integrated with the global. At that time, the Indian economy was at the crest of an extended boom, driven by both strong export growth and buoyant domestic demand. The principal shock was essentially through the trade side, where our exports collapsed, registering a negative growth of around -15% in 2009-10. This was a pure demand shock. Since exports accounted for roughly 21% of GDP (gross domestic product), this translated to a demand reduction of about 3% of GDP for the year. Left to itself, this reduction would have worked through the multiplier and led to a reduction in the GDP growth rate of 9 percentage points, which would have meant at best a zero growth rate for 2009-10, going up to maybe around 4.5% in the following year.

As it turned out, the growth rate in 2009-10 was 4.6%, rising to nearly 10% in 2010-11. This did not happen by itself. The Indian government stepped in with a substantial fiscal stimulus package of nearly 3% of GDP in 2009-10, which was about equal to the demand-depressing effect of the export contraction. Sagacity on the part of the Indian government? Not entirely. A large part of the stimulus actually preceded the crisis as part of the political build-up to the 2009 general elections, but it was fortuitous and the government did carry it through and added an excise cut to top it off. 

There are three lessons to be learned from this experience:

  • A large exogenous demand shock requires an equally large fiscal policy response.
  • A fiscal stimulus package takes time to work through the system. Given the normal preparatory work required by the government machinery to convert policy into action, 4 to 5 months can pass before any expenditure is actually made. Thus, such stimuli are always back-loaded in terms of their impact.2
  • Direct income support to the poor has a much larger effect on agricultural prices and relatively low multiplier effects on production since 70% of the initial expenditure is on food – a supply-constrained sector.3


The demonetisation episode was a different kettle of fish altogether. In 2016, as in 2008, the economy was well on the upswing of the business cycle with both demand and supply growing strongly in tandem. The demonetisation did not directly affect either demand or supply – a fact that appears to have little recognition in the extant literature. It was a shock to transactions. Thus, its impact on the economic system depended largely upon the degree to which different segments of the economy were dependent upon cash transactions.  

Unsurprisingly, the informal micro-enterprises sectors, including agriculture, were the worst affected since practically all their transaction, both upstream and downstream, were cash-based. Agriculture was particularly interesting since the traders in agri-markets simply did not have the cash to make their usual purchase.4 As a result, farmers faced what was essentially a demand shock, and prices crashed. In stark contrast, the corporate sector was virtually unscathed since almost all its transactions were non-cash. 

The small and medium enterprises (SMEs) fell somewhere in between since their transactions were both cash and non-cash, depending upon who they were transacting with. However, as these units were beginning to come to terms with the demonetisation shock, they were hit by the somewhat botched roll-out of GST. These units were in no position to meet the very demanding stipulations of this tax, which resulted in further decimation of this sector.

Ironically, the corporate sector (and some SMEs) actually gained as a fair number of final consumers shifted a part of their purchases from the informal retail system to the formal where payments could be made without cash.5 This meant a positive demand shock for corporates and some SMEs and a negative demand shock for the rest. 

In all of this, the government was nowhere in sight. Absolutely no policy measures were taken to address the damage that was being done to informal sector; especially to agriculture and the trader class – the traditional support base of the ruling BJP (Bharatiya Janata Party). There was, however, an element of resilience that became evident. Most cash transactions in India are not based on any formal contract but on relationships and trust. As a result, a fair proportion of transactions continued in the cash economy on a ‘payable when able’ basis. This of course did not work where the informal sector was buying goods and services from the formal. There was, thus, an element of a supply shock to the informal sector from this. 

The real problem faced by the informal and SME sectors was servicing of their debt to banks and NBFCs (non-banking financial companies), which had to be paid on time to avoid being classified as ‘non-performing assets’ (NPAs) and become liable for recovery proceedings. This could have been devastating if it had not been for the existence of MUDRA6 loans. Many micro and small units borrowed from this window to meet their debt servicing obligations on existing loans.7This effectively kicked the can down the road, hopefully until the remonetisation process was completed.  Nevertheless, a very large number of loans to micro and small companies became NPAs and forced these units to close.

What was surprising was that despite palpable damage to significant parts of the Indian economy, GDP growth in 2017-18 was estimated at 8.2% - the highest since 2012-13. Unfortunately, this was an optical (or more correctly, a statistical) illusion.  Apart from agriculture, Indian GDP estimates are primarily based on data from the organised sector, which is extrapolated to cover the informal and SME sectors as well.8 Since, as has been already explained, the formal sector actually gained at the expense of the informal and the small, this procedure grossly overestimated the growth rate. Thus, while the higher production of corporates got recorded, the presumptive negative growth of the SME sector was completely ignored.

While there is no data to directly estimate the extent of GDP overestimation, two corroborative datasets suggest the damage was significant. Employment data from the Periodic Labour Force Survey (PLFS) for 2017-18 indicated that the unemployment rate was 3 percentage points higher than normal. Similarly, household consumption data indicated that per capita monthly consumption expenditure was 2% lower than in 2011-12.9

The denouement came in mid-2018, when GDP growth started slipping steadily. It has now been more than six quarters that the growth rate has declined quarter by quarter from 8% to 4.5%. The damage done to the informal and SME sectors had now started showing up in corporate results as well, through its effect on incomes and demand. It had also shown up in a steady decline in the household savings rate and/or increased borrowings as households attempted to protect their consumption in the face of declining incomes. The government, however, continued to be in a state of denial and took no corrective measure other than an income support scheme for farmers (PM-KISAN).10

The lessons to be learnt from this episode are more complex:

  • Not all shocks can be neatly classified into demand or supply shocks. This complicates policy response since the economics literature addresses each kind of shock separately.
  • In a scenario of mixed shocks, policy necessarily has to be far more nuanced and targeted, and requires a much higher level of sophistication on the part of the policymakers. It also requires administrative and governance standards of a high order. Of course, this episode sheds no direct light on the quality of policy and governance in India since here was no policy response worth the name.
  • The informal sector does have a certain degree of resilience because of its ability to work through social networks and renegotiating informal contracts. Nevertheless, its earnings tend to decline, sometimes sharply.
  • The most vulnerable are the SMEs, which have little staying power, and are bound to formal contracts without the clout to renegotiate them. The most damaging of these is servicing of debt taken from the formal sector (banks and NBFCs).
  • The corporate sector has greater staying power, but is not immune to the demand destruction that takes place because of the problems faced by the informal and SME sectors.
  • In the absence of appropriate policy response, effects of a shock can persist for an extended period. Thus, whether a recovery is V-, W-, U- or L-shaped depends both upon the nature of the shock and the policy response.

In the next part of the series (to be posted on Saturday, 6 June 2020) Dr Pronab Sen estimates the damage to the economy due to the lockdown and export slowdown, taking into account the fiscal stimulus announced by the government so far. Presenting the expected trajectory of the economy over the next three years, he contends that the likely recovery path is not a V, but an elongated U, maybe even closer to an L. 


  1. This is one instance in which India represents the gold standard. On a scale of 1 to 100, India is at 100 whereas all other countries are between 60 and 80.
  2. This is the principal reason why the 2009-10 fiscal stimulus had its full effect only in 2010-11.
  3. About 10% of the 2009-10 fiscal stimulus was on MNREGA (Mahatma Gandhi National Rural Employment Guarantee Act). This step was necessary in any case since 2009 saw one of the worst droughts in recent years and income support to the poor was a moral imperative. However, it should also be acknowledged that a large part of the first-round effects of this increase was dissipated through a sharp increase in food prices. I realise that this goes against the classic Keynesian prescription of “digging holes and filling them up”, but, as I explain later, much depends upon the specific conditions under which the fiscal stimulus is being given.
  4. Government procurement of agricultural products is only about 8% of total output. Practically all the rest is either self-consumed or sold through private traders.
  5. These were consumers who had credit/debit cards. The numbers of such persons was relatively small as a proportion of the population, but their share in total consumption demand was disproportionately large.
  6. Micro Units Development and Refinance Agency (MUDRA) was set up in 2015 to provide small collateral-free loans to micro units through the banking sector.
  7. MUDRA loans shot up in 2017-18 after showing tepid performance in the previous two years.
  8. In the case of agriculture, the GDP estimates measure only production, and not income of farmers or losses arising from increased wastage.
  9. The 2017-18 Consumption Expenditure Survey data has officially been suppressed by the government.
  10. The government’s narrative was, is and will continue to be that the demonetisation was a stroke of genius and will have no lasting effect on the economy.
1 Comment:

By: Uttam Bhattacharya

Interested to join and learn the opinions.

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