Will today’s economic scratch leave a scar?

Context: Numerous factors are holding back the potential growth of India, which is necessary for a sustained recovery. The future of growth depends on cleaning and reforming the damaged economy of India.

Significance of the concept of ‘potential growth’: It refers to the level of economic growth that can be sustained without stoking inflation or other micro imbalances.

• Long-term equity investors pin their hopes on high potential growth when building up their positions.
• It influences the sovereign ratings that India receives by determining the level of public borrowings.
• It helps policymakers in devising proper fiscal support.

Factors affecting India’s Potential Growth: Potential growth could fall by 1% to 5% in post-pandemic world.

• Weak global growth environment: Potential growth fell from over 7% before the global financial crisis to 6% on the eve of a pandemic.

• Labour displacement: Rural migration has impacted the availability of labour in cities. However, it is expected that migrants will return to the cities post-pandemic.

• About 60% of the rural migration is aspiration led.
• Government policies to boost rural wages might retain some workers in villages, but the workers searching for higher-income will move back to urban areas.

• Weak financial sector: It could act as the key driver of 1 percentage point drop in potential growth.

• Growth in the sector was slowing even before the pandemic, with rising non-performing assets and shadow banking facing liquidity issues.
• Benefits of the buoyant capital market go mostly to the highly rated companies; lack of demand would resist trickle-down of the benefits to small vendors.
• The softening of bank credit and rising dependence on corporate bonds suggests that bond market buoyancy was not able to offset banking distress.

• Damaged Consumer and government spending: as both are grappling with their problems:

• Consumers are uncertain about jobs.
• The government has entered the pandemic with elevated debt load and is not able to expand much.

Way Forward:

• Important reforms needed:

• To tackle the reasons for previous buildup of bad loans like those related to the land and power sector.
• To clean up corporate/bank balance sheets (E.g.: more efficient Insolvency and Bankruptcy Code)