By Pranjul Bhandari, Aayushi Chaudary & Priya Mehrishi
Good news first. India’s second pandemic wave may be showing the first signs of peaking. Recoveries are rising and the positivity ratio is falling in states that imposed early lockdowns. Yet, this is not a time for complacency. The overall number of new cases as well as nationwide positivity rates remain persistently high. And, some of the economic costs of this wave could outlive local lockdowns.
Rewind back to 2020. A stringent national lockdown resulted in a sharp contraction in growth (GVA fell 23% q-o-q in the April-June quarter). But this was followed by a sharp uptick (of 19% q-o-q in the July-September quarter), led by various factors, namely, pent-up demand from consumers, restocking demand by sellers, and gains from formalisation by producers.
The dominant narrative this time around is that in a bid to keep the economic cost of the pandemic wave contained, a national lockdown has been avoided. As such, even though local lockdowns are being imposed as the pandemic spreads, the overall cost should just be a fraction of what India witnessed last year. Indeed, economic indicators such as the PMI indices and GST collections are holding on rather well this time. And as the wave subsides, the recovery that takes hold in the next quarter (July-September), should be emboldened further by a rise in vaccination rates.
While this narrative is not altogether wrong, we think it may be too simplistic. Understanding the various dimensions on which the second wave differs from the first is critical to truly understanding its economic cost and the recovery path. The second wave differs from the first in four ways, each stoking uncertainty.
One, staggered state and local-level lockdowns may feel less stringent than a national one, but they come with huge uncertainty around timing and impact. Which state is going in next? How long will the lockdown be extended for? Will interstate trade be hurt? And will subsequent waves bring back such lockdowns?
Two, the urban spread of the second wave is more concentrated amongst more affluent households this time. Data from the Mumbai municipal corporation, for instance, shows that 34% of the cases were in buildings in the first wave, compared to 90% this time around. To the extent that better-off households drive more consumption demand, weak sentiment amongst them could keep pent-up demand subdued.
Three, the disease is showing signs of spreading into the rural heartland, more so than during the first wave. For instance, rural India accounted for 21.1% of the country’s pandemic cases in April 2020, and 44.1% in April 2021.
Four, with rising global commodity prices, domestic manufacturers are grappling with falling margins. Low commodity prices and emergency cost cutting helped corporates tide over the first wave. But this time around, corporates may find themselves stuck between a rock and a hard place.
On the one hand global commodity prices are on the rise and it is hard to do emergency cost-cutting for a second year in a row. On the other, domestic demand is vulnerable and passing on higher prices to consumers risks weakening demand further. Thus far, firms have been taking it on the chin, i.e., on their profit margins. But is this sustainable? Bringing all of this together, we forecast GVA to grow 7% y-o-y in FY22 (versus our forecast of 10.2% earlier). The forecast for GDP growth is 8% y-o-y in FY22 (versus 11.2% earlier).
The government’s budget plan to repay past years’ food subsidy arrears to the FCI is a good step, but will end up distorting GDP growth numbers, particularly because the FCI follows “accrual accounting” while the government is following “cash accounting”. We estimate a c1 percentage point (ppt) GDP growth overestimation in FY22 and a c0.5ppt overestimation in FY23, which are embedded in our GDP forecasts.
For FY23, we forecast GVA to growth 5.3% (5.1% earlier), and GDP to grow 6% (5.8% earlier). Even though we expect the country will get back to pre-pandemic GDP levels by end-2021, it is likely to stay 12% below the pre-pandemic path, even by FY23.Even while India was benefitting from a cyclical recovery a couple of months ago before the second wave struck, we were concerned about the scars that the first wave of the pandemic would leave behind—a weak financial system and rising inequality.
We had estimated then that these two could drag down India’s potential growth by 1ppt from 6% before the pandemic to 5% after .Now, with the new wave, not only has the cyclical recovery come under cloud, the scars anticipated may deepen further.
Currently, markets seem pretty relaxed about the twin-balance sheet problem. Capital buffers of banks have improved in recent quarters. After peaking in March 2018, NPAs at banks have also been on a downward trajectory. Some corporate deleveraging has happened, particularly with the ongoing rebound in equity markets. But it could worsen from here. NPAs are already double the long-term-average, and generally rise a year or two after a slowdown.
Industrial credit is weak and real personal loan growth has also been slowing. Investment by banks is outpacing credit outlays. All of these, in some sense, are signs of risk aversion building up in the banking sector. If banks become increasingly risk averse, the result could be inadequate loan growth, meaning not enough funds being available, which could weigh on medium-term growth potential.
Large, listed firms have benefitted through the pandemic and the resultant “formalisation” has showed up clearly in corporate results. Given the large efficiency gains associated with the formal sector, it is no surprise equity markets continue to cheer. But, if “formalisation” happens at the cost of putting small, informal firms out of business, then the disruption in the informal sector can weigh on demand in subsequent periods, lowering potential growth over time—85% of the labour force and 50% of the economy is informal.
It is also possible that formalisation wears off over time. This happened during demonetisation. Our study of corporate performance shows that given the ecosystem had not changed very much, the informal sector made a comeback. And in that case, the efficiency gains associated with formalisation wore off.
The constructive way to think about this is to differentiate between ‘forced’ and ‘organic’ formalisation. The formalisation that comes only on the back of external pressure or leads to deep distress in the informal sector, may either pull down potential growth or may not be sustainable. In contrast, formalisation that happens on the back of policy changes which help informal firms grow over time into larger formal sector firms, is more sustainable. Can India move from forced to desirable formalisation?
The immediate step for the economy is to speed up vaccination rates. It would need rise from 1.9 mn jabs/day to c5mn/day in order to vaccinate 50% of the population by end-2021.Beyond that, we see at least four key policy steps :
The IBC must be strengthened. It needs to be revamped— in particular, the incentive structure across debtors, creditors and the courts— for this important institution to become effective.
There is a case for remaining generous with NREGA, where demand for work is outstripping supply. India doesn’t have an equivalent urban social welfare scheme. Designing and implementing an urban social welfare scheme could provide reliable support.
While the Centre’s capex focus in the February budget was a big positive, disinvestment would need to be fast tracked in order to make it achievable.
There is much excitement about Production Linked Incentive (PLI) schemes raising capex and jobs. While it can give an initial push, sustainable growth requires improvements in the ease of doing business, an R&D culture, and a move away from import tariffs.
The government has been raising import tariffs on a wide variety of goods over the last few years. Higher import tariffs can raise economy-wide cost of production, even working as a tax on exports. Past attempts of import substitution– export promotion, have not worked out.
Respectively, chief economist (India), economist, and associate, HSBC Securities and Capital Markets (India) Private.
Views are personal.
Edited excerpts from HSBC Global Research’s India’s cost of uncertainty report, dated May 13