India started its fight against the Covid-19 pandemic with a nationwide lockdown from March 24 midnight, and rightly so, given its high population density, fragile health infrastructure and limited fiscal capacity. With its extension to May 3, domestic shock of lockdown is now more dominant. The auto sector contracted 44% and exports 35% in March 2020. April promises to be worse. Although some economic activities resumed since April 20, these are in select areas and dependent on the pandemic spread. In view of these developments, we have revised our India growth outlook to 1.8% from 3.5% for fiscal 2021.

Tightening of global financial conditions adversely affected domestic markets and limited the ability to support the economy through credit flows. The weakness in India’s financial system has gradually transmitted from public sector banks to non-banking financial companies and even private sector banks. The Reserve Bank of India’s (RBI) measures to ease domestic financial conditions will help mitigate stress slightly. However, credit-quality trends will ultimately depend on the pace of economic recovery, demand resilience in specific sectors, and normalisation of working capital cycles.

The government announced a slew of policy measures to address the economic fallout of the lockdown. So far, monetary policy is playing a bigger role than fiscal stimulus, which seems minuscule in relation to the developed world. While these steps are a welcome relief, the government seems to be taking measured steps and not trying to front-load its response, unlike in many other nations that have proactively announced large fiscal-support packages. The Indian government, therefore, needs to step up its fiscal response drastically. The government seems to be working on another stimulus package, which should hopefully address these issues.

The dilemma for policymakers is between extending, lifting and partially easing lockdown measures, even as concerns exist around fighting the crisis; protecting health even after the virus spread is contained; virus flare up after lifting of social distancing; and ensuring a smooth economic recovery. Eventually, the containment of domestic spread, duration of domestic lockdown, extent of global slump, and domestic policy support to recovery, will decide the shape of economic recovery.