Infra spending is good, but what is needed to mitigate the pandemic’s impact is spending to support income

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October 19, 2021 4:00 AM

Policies need to focus on minimising this massive income loss from the pandemic’s permanent scarring.

infraThe government appears to be fixated on finding new sources of revenue through the privatisation and monetisation of its assets

If a tree falls in a forest and no one is around to hear it, does it make a sound? This seems to be the case with the alphabet war about the shape of India’s recovery from the pandemic. At first glance, all this appears to be just semantics. How does it really matter if the recovery is “V”, “W” or “K” shaped? It doesn’t. Unless policies are being based on the perceived shape.

But before we get to that, here are some facts about India’s recent growth performance. If we use the antiquated year-over-year growth rate, as calculated and published by the CSO, then the story runs something like this: After plunging 24.4% in 2Q20 and then 7.4% in the next quarter, growth turned mildly positive in the next two (0.5 and 1.6%, respectively) before printing an outsized 20.1% rate in 2Q21. Some saw at this as proof of the start of a “V” shaped recovery and that of the economy’s resilience as it clocked the highest growth rate in the world despite being devastated by the Delta wave. Others promptly pointed out that the high growth rate was just a statistical artifact of a very low base in 2Q20.

All this head-scratching about “base” effects is not just unnecessary but a wasteful diversion. The problems with using year-ago growth rate as an indicator of an economy’s cyclical position have been known at least since the 1940s, the key issue being it does not provide any sense of the current cyclical position, i.e., whether the economy is accelerating or decelerating. It just tells the state of the economy relative to what happened four quarters ago. Imagine driving a car with a speedometer that only tells the speed compared to what it was four hours ago. It would be very difficult to know when to brake and when to accelerate. In the same vein, not knowing whether the economy is accelerating or decelerating makes it very hard to know whether to tighten or ease policies. Indeed, the year-ago growth numbers often provide completely the opposite signal, as is the case now.

Thus, all advanced and most of the larger emerging economies have abandoned using year-ago growth rates as a cyclical indicator of the economy and to formulate policies. Instead, they have shifted to quarter-on-quarter deseasonalised growth rates. The techniques for doing so have become common place. Any rudimentary econometrics package contain these methods and the US Census Bureau (among others) has made them publicly available. Since India’s CSO does not provide quarterly sequential growth numbers, we are left to our own devices. Using a standard deseasonlising methodology, we estimate that in 2Q20, the level of real GDP fell 22% compared to the level in 1Q20, then rose 18.5%, 6.5%, and 2.5%, respectively in the next three quarters.

India had its “V” shaped recovery. Over 3Q20-1Q21. And, in all the three quarters, India clocked the highest growth rate in the world. Alas, our collective sight was too focused on CSO’s antiquated year-ago growth rates. There was no one around to hear the proverbial tree fall.

What happened in 2Q21? GDP fell 6.3% compared to its level in the previous quarter! This should not be surprising given the damage from the Delta wave. Since then, high frequency indicators suggest that activity is recovering, albeit modestly. We expect growth in 2021-22 to be around 8.5%, up from the -7.3% print in the previous fiscal year. But this is not good enough. If one takes the government’s view that India’s medium-term growth potential is around 7-8%, then the level of GDP at the end of 2021-22 will be 8-9% below that implied by the pre-pandemic path. To make up this loss in 2022-23, GDP growth has to be an astonishing 16%. We expect growth in 2022-23 to be around 7.5%. But even with this reasonably strong rate, the income loss will widen further to 11% of the pre-pandemic path, amounting to around $350 billion.

We also know that the loss is unlikely to be distributed uniformly. Listed company profits have remained very strong, consequently the loss to households and SMEs is likely to be much larger. Some private surveys suggests the unemployment rate (controlling for a fall in the labour participation rate) has increased to about 12% and two-wheeler sales have fallen 30% across January to August compared to the same period in 2019, suggesting the balance sheets of low-income earners have been hit significantly. This damage to balance sheets might not be showing up in banks’ credit quality at present because of RBI’s extensive regulatory forbearance, but as regulations are normalised, NPLs of households and SMEs are likely to surge. This could seriously hamper the SMEs’ ability to access credit and invest. And they remain India’s largest employer.

Policies need to focus on minimising this massive income loss from the pandemic’s permanent scarring. And fiscal policy is key. The government appears to be fixated on finding new sources of revenue through the privatisation and monetisation of its assets. These are worthy objectives. But that’s just half the problem. If the existing resources (and the added revenue) is spent on building infrastructure, which today is highly capital-intensive and mechanised such that these projects no longer generate jobs or support SMEs as they used in the past, the looming impairing of household and SME balance sheets is unlikely to be mitigated.

Over time, the investment in infrastructure today will increase productivity and open up many business opportunities. But India needs to have strong balance sheets across corporates, SMEs, and households to reap these benefits. At the risk of sounding like a broken record, the problem at present is not inadequate public revenue, but the imbalance in public spending. It needs to be directed markedly more towards income support than infrastructure. India might get to build many new roads and airports in the coming years, but if balance sheets are indeed damaged, then there might not be many who can afford to use them.


Jahangir Aziz, Chief Emerging Markets economist, JP Morgan
(Views are personal)

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