Learning from the Past Crises – Possibility of Early Recovery

– Dr. Martin Patrick and Dr. Joshy KJ

The world has undergone several economic crises at different time periods. The Great Depression of the thirties of 20th century has been discussed at length by academicians and politicians. The Depression was followed by a number of financial episodes due to the great thrust given to financial market. The financial crisis 2008, which is widely regarded as a Great Recession for the countries in the West, was one such event the world had witnessed in the recent past. There were sector-specific crises between these two great economic episodes. One famous crisis was in the information technology sector, popularly known as dotcom bubble of 2001. An interesting inference is that the capitalist countries often corrected a crisis with a policy that led to another crisis within a short span of time. India cannot be easily included in this club mainly due to two reasons; one, it is not strictly considered a capitalist country because of its strong public- private sector coexistence (especially before the economic reforms in 1991) and two, India could easily overcome the adverse effects of Great Recession 2008 without much of discretionary policy interventions. However, the situation has changed after 1991 with the wedding of a more liberalised environment and at present the country has been facing a slowdown since the fourth quarter of FY2018-19.

Slowdown plus COVID-19: The Real Blows

The Indian economy was well-positioned during the period of financial crisis 2008. The growth rate, performance public sector banks, monitoring of private banks by the Central Bank etc were good so as to contain the adverse effects of Recession easily. Unlike this, the present situation presents a bleak and gloomy picture. The economy was already on a downward trajectory of growth since the turn of FY2018-19. On a quarterly basis, India’s growth rate fell from around 8 per cent in Q4 FY18 to a new low of 4.5 per cent in Q2 FY 20. As a result, international rating agencies downgraded the performance of Indian economy even before the onslaught of pandemic crisis. The high fiscal deficit of the government before the pre-COVID-19 period coupled with increasing unemployment rate (the highest in 45 years) gave heavy blows to both demand and supply side factors during the pre-COVID-19 period itself. Further, the financial sector is already under severe stress with twin balance sheet problem. These were absent during the 2008 recession period and hence India could survive that crisis easily. With arrival of COVID-19, the economy has been trapped into a dismal condition which appears to be very complex to deal with.

What is important at this juncture is whether we learn from the previous crises and what kind of policies are made accordingly? To see this, the present crisis needs to be compared with the earlier ones. For the sake of simplicity, an attempt is made to compare the present crisis with the most recent one, that is the 2008 financial crisis.

Comparing the Pandemic Crisis with Recession 2008

The 2008 Recession started in the US due to a sub- prime crisis and subsequently it spread over to other parts of the world. The sub-prime crisis in turn was caused by the deregulation of financial markets (aggressive since 1990s), followed by risk pricing which replaced prudential supervision, the rise of ‘derivative assets’ with opaque markets and few players, and above all credit- induced consumption of Americans. Along with this, factors like the then soaring oil prices, the cost of the US government accrued for Iraq war, and correction of 2001 dotcom bubble with monetary easing etc also led to the unavoidable crisis. The susceptibility of developed economies in absorbing the crisis did impact the most emerging economies, especially those dependent on commodity exports.

As compared to recession, the present crisis is the result of a pandemic, not because of bad or misdirected economic policy except a few countries like India and some European countries where the signs of slowdown had been present even before the COVID-19 period. Unlike recession the pandemic has affected most of the countries in the world. In other words, the spread of current crisis is more severe than recession but the intensity cannot be understood at this stage. It is treated a war like situation as it has affected both supply and demand sides. Hence, it needs to be portrayed the sharp differences in the characteristics of these two episodes.

Three major characteristics can be highlighted in this connection. Firstly, the crisis 2008 has mainly affected the financial sector in the initial phases, however, it gradually passed on to the real economy. Unlike the 2008 financial crisis, the impact of COVID-19 would be so destructive on the real economy at the beginning stage itself. The current crisis has its negative impact on the overall macroeconomic scenario with its direct influence on labour market, goods market and currency or financial market. The negative impact on the production scenario acts as a disincentive to manufacturers and thereby it reduces the income levels of people leading to a decline in the household consumption expenditure.

Secondly, recession was largely a supply side problem initially, but graduated into demand side problem too later whereas the current crisis is characterised by both demand and supply side factors simultaneously from the initial phase itself. COVID-19 has serious implications on cross border scenarios too. One such aspect is the possible changes in the over reliance of international supply chains. The pandemic has demonstrated the ugly side of over dependence on global supply chains although it offers with several advantages. Further, it is possible that investors looking for better pastures may turn their eyes to newer destinations. A country may not be in a position to raise resources from external sources, since the burden of pandemic is borne by all the countries.

Third, the equity market crash is also different in terms of the intensity of fall and duration of the bear market. When the present market crash due to pandemic is discussed, it needs to be compared with 2001 dotcom bubble and 2008 market crash. The decline in the market from its peak needs to be at least 20 percent to qualify as a bear market. While the loss of Sensex was 46 percent from its peak following the dotcom bubble of 2001, it was 64 percent during 2008 crisis. The former lasted more than 10 months whereas the latter continued for around 18 months. In comparison to these, the current crisis has just passed four months with a deepening effect and the Sensex has lost hardly 20 percent from its peak. It is interesting to note that the stock market has revived without any sign of improvement in the economy, particularly from the manufacturing sector. Hence, the fear of further fall or crash in the stock market may translate into reality within a few months if the economy continues to remain in the depressed state.

Global and Indian Strategies to Combat Crisis

Most of the countries addressed the 2007-08 crises with ‘bail- out packages’ followed by spending for job creation. Is this the right strategy to overcome the economic crisis that arises due to a pandemic? Have the Western Countries adopted correct methods so far to surpass the economic issues emerged from the global pandemic? Really, they learnt lessons from the Great Depression of 1930s, the Second World War and the Recession of 2008. Recognising the fact that the present crisis is similar to the war time situations, advanced countries like the US, Great Britain, Germany, Australia, France, Canada etc. have adopted aggressive direct spending through fiscal and monetary stimulus packages.

The economic policies adopted by the Government of India are in similar lines. However, the packages announced by the Government so far, show a heavy thrust on monetary stimulus with a lesser thrust on the fiscal stimulus through direct spending. The current situation is so precarious that the livelihood of millions of common people is at stake and hence the consumption demand is collapsed which necessitates the need for tackling the demand constraint. Hardly one percent of the so-called 20 lakh crore is earmarked for direct spending. Adding to this a number of reform measures are announced. The Government may be trying to turn the current crisis into an opportunity for implementing economic reforms. However, an economic recovery might be a better start prior to implementing economic reforms. In addition, the need of the hour is to restore the confidence of investors as private investment has been declining for the past five years after boosting the consumption demand. It may create a gap in terms of the growth trajectory for the future as the usual consumption demand- investment demand linkage doesn’t seem to roll the ball. As the Chief Economist of Goldman Sachs observes, “With the economy likely to contract by 5 per cent in the current fiscal we are talking about a loss of 20 lakh crore. What is the framework, the government strategy to make up for this loss?”. The future looks bleak and absolutely disappointing, with regard to recovery path. The rating agencies, both domestic and global, are more concerned about India not having a strong fiscal and administrative strategy in place.

The Nature of Recovery Ahead

Looking from the perspective of the policies announced by different countries of the world, there is every chance that advanced countries may recover soon though the world would jump into a negative growth during the fiscal 2021. The pertinent question here is whether India can tackle the present crisis by minimising the losses as the other countries do. One of the key aspects is that the heavy dependence on monetary policy is not a wise step at this juncture. It must be noted that the monetary stimulus has its limitations, given the Twin Balance Sheet (TBS) problem in the banking and corporate sectors. In this context the policy should be directed towards a big push for direct spending through fiscal stimulus followed by bail outs and monetary policy easing. In other words, India has reversed the policy that is required during the current period. No doubt monetary policy and bailout packages are necessary but it should be after an aggressive direct spending in the initial stages. Hence, there is every chance that India may take longer time as compared to its counterparts for a revival from the current situation.

There are chances that the combination of demand and supply shocks together will hit the economy hard at a time when the tools to deal with the crisis are impaired. The result may be a slow recovery after getting into a ‘great recession’. And the recovery will not be ‘V’ type as usually expected but rather a ‘U’ recovery. Even the chance of an ‘L’ recovery cannot be brushed aside, if it is not for India at least in the case of some other countries. Taking all the odds into account, the possibility for a U recovery is the highest for India. One of the reasons is the fair contribution of the agriculture sector during this time. The earlier economic contractions like 1957-58, 1965-66 and 1979-80 had witnessed a poor performance of the agriculture sector which fuelled the fall in the overall growth scenario. The current crisis associated with COVID-19 is intensified by the steep decline in the contribution of manufacturing and service sectors. It is important to mention that there are some specific measures in the packages for the revival of these sectors. But the unavoidable time lag associated with them may delay the returns. If the Government had pumped more money into the economy by way of direct spending V recovery would have been a reality.

To conclude, there is every possibility that the fall in income and employment being experienced across the world may remain as a short or medium term phenomenon for most of the advanced economies due to their reliance on aggressive direct spending with adequate emphasis on the monetary policy measures. Unless the Central Government has a similar focus on immediate recovery and direct spending rather than economic reforms, India may have to face more challenging times ahead in order to get rid of the clutches of a prolonged recession.

Contributed by:

Dr. Martin Patrick – Economist and Honorary Fellow at Centre for Budgetary Studies, Cochin University

Dr. Joshy KJ – Associate Professor and Head, Department of Economics, CHRIST (Deemed to be University), Bangalore

Picture Credits:

Most Popular

To Top