With COVID-19 cases escalating and the lockdown extended, brace for a sharp economic cost and more policy easing
By Sonal Varma & Aurodeep Nandi
Extended periods of below-trend activity can have multiple knock-on effects. The major domino effects of COVID-19 that could sustain long after the direct economic effects fade include corporate cash flows and bankruptcy risks, particularly challenging for small- and medium-sized enterprises (SMEs), worsening unemployment and labour force participation rates, and fiscal and debt sustainability risks.
Our economic forecasts currently incorporate the direct effects of social distancing measures (until late April), the spillover effects from weak external demand, and some collateral damage. The experience of countries that have successfully flattened the curve thus far suggests the duration of the lockdown could be longer and, even after a strict lockdown ends, social distancing measures will remain in place. Thus, while the peak economic hit will be seen in Q2, activity will likely remain below-potential for much longer. In India, it is quite likely that even once the lockdown period ends, the public fear factor will still result in below-normal activity for a few more months. Even if demand for durable goods picks up after a few months, consumption of services will be permanently lost.
Unemployment: According to the Centre for Monitoring Indian Economy (CMIE), a private agency, India’s unemployment rate spiked to over ~23% as of April 5 versus the 6-8% range pre-COVID-19. The unemployment rate in rural India rose to ~20%, and to ~31% in urban India, indicating that while the outbreak started off as an urban phenomenon, the economic impact is also being felt in rural areas.
Labour force participation rate—the number of employed and those seeking employment as a percentage of the working age population—dipped sharply to ~36% from its pre-COVID-19 trend range of 42-43%. CMIE estimates that the labour force has fallen by 9 million people (from 443 million in January to 434 million in March).
The deteriorating labour statistics are a direct consequence of the COVID-19-led national lockdown. It matches anecdotal evidence in the past few weeks of a mass exodus of labourers, particularly in northern India, from urban centres to their rural hometowns. Based on the usual status of employment, nearly 52% of the labour force is self-employed, and around 23% are casual workers.
We expect unemployment to remain elevated, with a longer period of lockdown and more growth damage.
Forecast revisions: For 2020, we have sharply lowered our forecasts for GDP to -0.5% (from 4.5%), averaging 3.1% in Q1,-6.1% in Q2, before recovering to -0.5% in Q3 and 1.4% in Q4, and for the current account deficit to 0.7% of GDP (from 0.8%). We now expect cumulative repo rate cuts of 75 bps to be delivered in Q2 and Q3.
Activity: With there now being over 5,000 positive COVID-19 cases in India, there is an increased likelihood of the ongoing national lockdown extending beyond mid-April, or of its exit being staggered. We expect a direct output loss of ~4.5%, and brace for indirect impacts like a sharp increase in corporate and banking sector stress and unemployment. High-frequency indicators such as PMI data for March show a decline in manufacturing, while the services index moved into contractionary territory.
Inflation: Although inflation is on a downward trajectory, we expect it to remain elevated in the near term due to high food-related inflationary pressures, which the lockdown has accentuated. Yet, the sharp de-escalation of global crude oil prices, alongside the massive demand slowdown, is likely to depress core inflation. We expect CPI inflation to average 5.1% in 2020—at 6.2% in H1 2020, before easing to 2.6% in H2.
Policy: So far, RBI has announced a raft of policy easing measures, including an inter-meeting 75 bps cut to the repo rate, a 100 bps reduction in the CRR, as well as targeted LTROs and forbearance measures. We believe more easing is likely, including 75 bps more of repo rate cuts, and further unconventional policy measures. However, the next stimulus will have to come from the fiscal side, beyond the conservative package of ~0.8% of GDP announced so far. The next tranche is likely to be aimed at cash-flow challenges faced by SMEs, and other hard-hit industries. We believe the central government’s fiscal deficit will widen to 5.1% of GDP in FY21, well above the 3.5% target.
Risks: A worsening COVID-19 outbreak, financial instability, and fiscal slippage are downside risks. A rapid post-lockdown recovery from the slump in Q2 is an upside risk.
Authors are Research Analysts, Asia Economics, Nomura. Views are personal
Edited excerpts from Nomura’s ‘Asia Economic Monthly: Knock-on effects of Covid-19’ (April 9, 2020)