It will help revive economic activity, but there are deep-seated issues—and Covid-induced ones—that need fixing
Growth had all but collapsed to 4.2% in FY20, even in FY19 it was just above 6%.
A rebound to levels of 9% in FY22 and a 6% uptick in the two years thereafter. That is the course the Indian economy is expected to chart in the near-term. The biggest promise that the coming year holds is the vaccine; it would not just speed up business activity, consumer confidence would soar too. But, the vaccine alone can’t help an economy that is hobbled by sluggish investments, lean credit flows and capital constraints. Rising prices of commodities and firmer interest rates will pinch, making both goods and services costlier. With the critical services sector lagging, and expected to recover only very slowly, new jobs will stay scarce; this, together with incomes that are barely growing, will keep consumption demand weak.
Already, between FY14 and FY19, nominal household disposable incomes grew slower by an average of six percentage points than in the previous five years. Moreover, even ahead of the pandemic, slowing disposable incomes had begun to weigh on the appetite for leverage-driven consumption, as seen in lower household leverage ratios in FY20. Until they are more confident, households are going to save rather than spend.
The consequent subdued demand will hurt smaller businesses, especially in the informal sector, though the larger companies will continue to recover. Nonetheless, a good many bigger corporations will focus on strengthening their balance sheets before they embark on fresh capacity additions. The recent announcements notwithstanding, private sector investments will, in aggregate, stay sluggish for at least two more years, extending the slump in the capex cycle.
As economists like Pranjul Bhandari of HSBC have opined, the pace of revival is likely to be gradual and heavily dependent on policy support. In the absence of a predictable policy environment, a strong pipeline of reforms to keep future expectations of growth buoyant and further steps to tackle the twin balance sheet problem, corporations would be reluctant to risk capital.
The government’s PLI—production-linked incentive—scheme sounds promising, but it could be a couple of years before sizeable capital is put to work. In the meanwhile, even the government might not be in a position to make big investments, given the finances of most state governments are expected to remain weak and compel them to scale back. The Centre could, however, resort to extra-budgetary borrowings to launch more projects. Right now, it is not clear how the capital formation in the household sector—about a third of the total—would trend.
Even as credit flows remain slow, only top tier companies will have access to the loan market. For weaker businesses, credit will stay elusive and expensive. Indeed, damage to banks’ balance sheets from rising loan losses can’t be ruled out, though the extent of capital erosion would be smaller than that seen in 2016-18. The loan moratoriums, regulatory forbearance and the absence of the IBC window are masking the stress in banks. The non-performing ratio will likely move up from 8.5% at the end of March, given there were stressed exposures even before the pandemic. The pain could leave lenders even more risk-averse—not helpful at a time when credit flows need to be broad-based.
The permanent loss to the economy from the pandemic, over the medium-term, is estimated at around 11-12% or roughly Rs 26-28 lakh crore. Getting back to the pre-pandemic trend value of real GDP would call for real GDP growth of about 11-12% annually for the next three fiscals. That seems way out of reach.
What could help somewhat soften the blow is a revival in global growth and trade; exports, which disappointingly contracted both in October and November, would get a fillip. As of now, global trade is estimated to contract 10% in CY20 before growing by 8% in CY21; based on this, India’s exports are tipped to contract 11% in FY21 before rebounding to grow at 13% in FY22. But, that is barely enough to lift the economy out of the rut that it is in.
What is needed now is a big fiscal stimulus. To be sure, the fisc will remain strained for a couple of years until tax collections pick up. The government has been reluctant to loosen its purse strings, possibly for fear of being rapped on the knuckles by the ratings agencies. However, it would do well to step up spending soon so that the recovery doesn’t stall, as is feared will happen, once the pent-up demand gets fulfilled. Should the recovery lose steam, it would be even harder to get it going again. So far, the direct spend in FY21 has been less than 2% of GDP; a much bigger impulse would be needed to ensure the recovery stays firmly entrenched even as the reforms are being rolled out.
As we have seen, it is the formal sector comprising bigger businesses that will emerge stronger while the much larger informal sector—which accounts for nearly half of the GDP and 80% of the jobs, continues to languish. As most economists have pointed out, this widening gulf between the haves and the have-nots would probably be the biggest blow dealt by the pandemic.
They have also observed how the pain in the informal sector is visible through reduced labour participation rates, anecdotal evidence of lost urban jobs, and a considerable pick-up in demand for MGNREGA—the rural employment guarantee scheme. The inequality is expected to worsen; 2021 will be the year of the haves, for the have-nots it might be worse than 2020.