When India does emerge from Covid-19, it will need high and sustainable economic growth to heal the economy. Can this be achieved by putting money in people’s hands and stoking demand? Money creation through fiscal and monetary policies should, indeed, spur domestic demand. However, in the past, we have struggled to grow domestic output and jobs alongside. As a result, instead of sustainable growth, we have had periodic bouts of inflation, external imbalance and financial instability.

Alongside any stimulus, real economy bottlenecks that come in the way of creating domestic jobs and output must be addressed. ‘Money’ here refers to the total of all bank deposits and currency in circulation. Monetary policy influences credit growth and foreign currency inflows, and, hence, the creation of money. Fiscal policies can directly impact the quantity of money in the system.

Generally, the more the money, the more the economic activity across consumption, production, savings, investments and trading in assets.

Which is why in the eight years from FY 2005-06 to FY 2012-13, India’s M3 (money supply) grew by 17.9% a year, and its nominal GDP and consumption grew by over 15% a year. Thereafter, from FY 2013-14 to FY 2019-20, its M3 growth slowed down to 10.5%, and nominal GDP growth to 10.8%.

However, while money can spur domestic demand and raise nominal GDP in the short run, without adequate domestic output and jobs, it can also lead to inflation and financial instability. For an emerging economy to achieve sustainable growth, domestic output over time has to, at least, match domestic demand, if not exceed it via net exports. If adequate job creation accompanies this growth in domestic output, a virtuous cycle of demand, supply, savings and investment can ensue.

China achieved such a cycle. Over the past 25 years, its money supply grew by 14% a year, and private consumption by 12% a year. Alongside, its real economy ensured expansion of domestic output well in excess of domestic demand. In fact, its net export of goods and services grew by 10% a year over the period, as it became the ‘factory of the world’.

In comparison, over 25 years, India’s money supply grew by 15% a year, and its nominal private consumption by 12.5%. However, its domestic output — particularly in manufacturing — has struggled to keep pace with domestic demand, let alone feed net exports. Instead, India’s net import of goods and services, largely feeding consumption rather than investment, grew by 23% a year over the period.

Get the Import?

With inadequate output and jobs, periods of high money and demand growth in India have opened up the risk of inflation and strained our external balance. Between FY 2005-06 and FY 2012-13, India’s net imports averaged 4.8% of GDP, while its rural consumer price index (CPI) inflation averaged 9.5%.

This is, by no means, a mercantilist case against imports. This is a case to expand our output and jobs, support higher domestic and external demand, without resorting to import tariffs that crimp our domestic competitiveness, or force austerity upon us. Over the years, credit growth, fiscal spending and net foreign currency inflows have all added to our money supply. The money created, however, has not been adequately productive. A chunk of India’s banking credit from a decade ago has ended up as non-performing assets (NPAs).

Sectors such as power and distribution companies, telecom, real estate, airline, and micro, small and medium enterprises (MSMEs) continue to soak up bank credit, without concomitant productivity benefits. Likewise, our larger-than-acknowledged fiscal deficits have largely funded revenue expenditure, rather than productive investments. Finally, over the years, net foreign currency inflows into India have been dominated by transient and opportunistic ‘carry’ flows. The productivity benefits from such flows are unclear. While the demand stoked by money creation should have created its own output, we missed the manufacturing bus, and made it easier to import than produce locally.

India’s real economy needs to respond to money creation with output and jobs. Otherwise, money creation alone risks inflation and financial instability. Notwithstanding some missteps, real sector reforms such as the goods and services tax (GST), the Insolvency and Bankruptcy Code (IBC), financial inclusion and digitisation are, indeed, underway. But many more bottlenecks still need to be cleared for jobs and output to be achieved.

First, our financial services ecosystem is in no shape to fund our growth aspirations. The overhang of NPAs needs to be addressed with a decisive one-time solution, such as a bad bank. We then need banking, governance and market reforms to make the system capable of creating quality money.

Reframe Reforms

Next, chronic stresses in real estate, power, telecom, airline and shipping, and MSMEs need to be addressed.

They continue to clog our money, output and job creation. Three, we have to address whatever puts off domestic entrepreneurs and global supply chains from creating output and jobs in India. This calls for persisting with ongoing land, labour, legal and policy reforms, seeking constant feedback, and doing more as needed. Finally, we have to invest much more in education, healthcare and nutrition. This would be the best way to lead our children to jobs and output, in a very uncertain future. Our real economy holds the answers to questions around the appropriate fiscal and monetary policies to pursue.


The writer is senior analyst, Observatory Group, and associate professor, SP Jain Institute of Management and Research, Mumbai