Recession, technical recession or depression?

Our GDP growth rate was negative to the tune of (-) 24 percent in the first quarter April to June of the present financial year 2020-21. It was expected to be negative at about (-) 8 to 10 percent in the second quarter ending September 2020. So, what does this mean? A negative growth rate in a single month is considered inconsequential and an aberration. If it continues to be negative for the entire quarter, then the economy is said to have entered a "recession." If the negative growth continues for two consequent quarters then the economy is said to have entered a "technical recession" meaning that the economy has started to contract according to accepted global economic parameters. Beyond this, negative growth can sometimes continue for many years. The United States of America, for example, had negative growth rates in seven out of nine years between 1930 and 1938. Such negative growth rates extending to many years are called "depression."

The International Monetary Fund (IMF) and the World Bank (WB) have made different assessments of the present situation. The IMF has assessed the present slowdown to be a "technical recession," that is, it expects the negative growth rate to turn positive soon. On the other hand, the WB has stated that the global economy has already entered into a "depression." The WB expects the negative growth rate to continue for a number of years. Both institutions agree that the global economy has contracted in the first two quarters of the present financial year and, therefore, we are in a technical recession. The difference is that the IMF expects the global economy to bounce back soon while the WB expects the negative growth rate to continue for many years as had happened in the United States in the thirties. The key question before us, therefore, is this: what will determine whether we will come out of the ongoing technical recession soon or after a long time?

The entire world is hopeful that vaccine will soon be developed to contain the Covid-9 pandemic. Many companies have claimed that vaccines developed by them are about 90 percent efficient. They hope to make these commercially available for widespread use very soon — maybe within a few months. The IMF has assessed that the technical recession will end soon on the basis of this best-case scenario. On the other hand, the Covid-19 virus is known to mutate rapidly and assume new forms. It is possible, nay, likely that a vaccine may be rendered ineffective against the mutated virus. A new round of the pandemic may then be unleashed. It has also been seen that the persons getting cured from Covid-19 do not often regain their earlier good health. Some continue to suffer from physical weakness, headache, breathlessness, etc.

The output produced by such persons will be less for a long time leading to lower growth rate. Much time may also be taken in the approval, commercial manufacture and in reaching the vaccine to the seven billion population of the world. This may take up to three years. Further, past experience suggest that the immediate impact of a financial crisis is less than the subsequent impact. Global economy, for example, had contracted by merely (-) 0.1 percent in 2008 when the last global financial crisis had erupted. It contracted by a huge (-) 2.5 percent in 2009. This means that an economic shock gets deeper just as a worker who does not get adequate food may continue to work at nominally reduced efficiency for one month but would collapse thereafter. It is not possible to forecast with any sense of credibility whether the present recession will remain "technical" as assessed by the IMF or it has already become a "depression" as assessed by the IMF because of these uncertainties.

The IMF and WB are also in agreement that nearly all countries have succeeded in averting a financial collapse by borrowing and keeping the wheels of their economies turning. This is a happy situation. However, both the institutions also agree that the economy will bounce back with fresh vigour after the pandemic only if the borrowed money is invested in education and technological upgradation just as the students engage in learning with fresh vigour after the summer vacations. Governments have adopted different strategies to make the borrowings, however. Some have borrowed from the market while others have asked their Central banks to print notes and provide the loans. Governments have borrowed money in both the cases. Difference is that the borrowing from the market leads in greater demand for loans, an increase in the interest rate, and a corresponding increase in the interest burden on the government. This increased burden can then lead to default by the government if the economy does not bounce back. The same loan when provided by printing of notes by the Central bank leads to an increase in the currency in circulation, to inflation and to debasement of the currency. Thus, whether the money is borrowed by the government from the market or the Central bank does not change the long-term scenario. The only difference is whether the borrowing will play out as a default by the government or as debasement of the currency.

We need to be careful. Moody's has already downgraded Indian government's debt to Baa3 category which is the lowest in "investment" grade. Any further downgrade will place our government debt in "junk" category and make it very difficult for the government to raise the loans from the market. It is necessary that the government deploys the borrowings so as to pull the economy out of the recession soon.

The IMF and WB both suggest that the loans taken by the governments to overcome the pandemic should be used for improving the skills and technology. That would be like the student spending a loan to learn a new course that would then enable her to crack the entrance examinations in the ensuing year. The same loan would push her into a deep pit if used for a pleasure trip. A trader from Faridabad recently told me that he made very good business selling packed sweets during the recent festivals. On being asked how he made good business when the economy was floundering, he said that the government employees had a steady stream of income and they made huge buying. This means that the government has used the loans taken during the pandemic to support consumption rather than investment. That does not augur well for our country.

(The writer is formerly Professor of Economics at IIM, Bengaluru)