Much of the debate in recent months has been focused on the sharp loss of economic momentum in India. The big question is whether the ongoing slowdown is structural or cyclical.

The usual thumb rule is that the policy response to a structural slowdown is through economic reforms that ease supply constraints. And a cyclical slowdown has to be tackled with measures to stimulate demand. Rathin Roy of the National Institute of Public Finance and Policy argues that India is currently facing a structural demand problem, which further complicates policy choices.

Another way to look at the situation now is through the prism of a growth recession. Economists define a recession as three consecutive quarters of contraction. Economic growth slips into negative territory during a recession. A growth recession is different. The economy does not contract. It continues to expand, but at a sequentially slower pace.

India has had three such growth recessions in the past 10 years. The first episode was in the immediate aftermath of the financial crisis that originated in the US. Economic growth fell sequentially in the three quarters from June 2008, or the second quarter of fiscal year 2009. The downturn was sharp, but short.

The second episode was after the effects of the 2009 stimulus wore off. Economic growth peaked in the three months ended March 2011, but slowed for five consecutive quarters after that. The policy paralysis during the last years of the Manmohan Singh government also pinched.

India is now in the third growth recession since 2008. Economic growth has already slowed sequentially for four consecutive quarters. It is very likely that economic growth in the quarter ended 30 June will be slower than in the quarter ended 31 March, at least going by the latest high frequency data, as well as various forecasts by private sector economists. The most recent goods and services tax (GST) collections data is also an indication of weak domestic demand, though the fact that indirect tax collection is growing slower than nominal GDP growth could also mean that demand that shifted to the formal sector after demonetization is again moving back to the informal sector.

In other words, it is highly probable that the current growth slowdown matches the one in the early years of this decade—though it could be shallower if one calculates the loss in momentum from peak to bottom. India cumulatively lost 5.5 percentage points of quarterly growth between the quarters ended March 2011 and June 2012. The loss in the current downturn is a relatively modest 2.6 percentage points.

What now? Many private sector economists seem to be expecting a cyclical revival after the third quarter of the current fiscal year. The average growth forecast of 32 professional forecasters polled by the Reserve Bank of India in July was 6.9%, a modest 30 basis points lower than the average estimate of the previous poll. However, it is likely that many have reworked their numbers since then, taking it closer to 6.4%. But even that is higher than the most recent quarterly growth rate and, hence, an indication that a modest growth recovery is expected later this fiscal year.

However, it is extremely risky at this juncture to merely bet on a natural recovery in economic growth. Slowdowns can feed on themselves through psychology, or what Keynes famously called “animal spirits". The signs of a tentative recovery in private sector investment have petered out. Consumer demand is weak, and the mess in the shadow banking system means that households no longer have the leverage option to maintain consumption in the face of slow income growth. The trade war has crimped international demand for exports.

A lot is thus riding on the policy response. The one big difference between the growth recession earlier this decade and the current one is that India has more macroeconomic stability. The balance of payments is in better shape even though the withdrawal of foreign money from the domestic capital market is a worry.

The biggest differentiator between then and now is inflation. It is under control, creating space for an immediate demand stimulus. There is definitely more space right now for a monetary stimulus rather than a fiscal stimulus. Total government borrowing is already soaking up most of the annual financial savings of Indian households, which is one reason why the government is trying to get access to foreign savings via a sovereign bond. The fiscal deficit is anyway likely to expand this year, given the unrealistic tax collection targets in the July budget, thus acting as an automatic stabilizer.

Monetary policy is the best bet right now. However, it works with a lag of around three quarters in India, which means that a rate cut today moves the demand needle nine months later. So, the fiscal lever may have to be used as a last option in case demand destruction continues. It should ideally be directed towards sectors such as home building, roads and automobiles that have strong links with other parts of the economy.

Finally, one brutal fact: If the Indian economy continues to lose momentum over the next two quarters, then the country will be in its longest growth recession in a decade.

Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai Academy of Economics.

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