Going by past experience and a possible second-round effect of the pandemic, India may have a wage problem, and it could get stuck in a low-growth equilibrium
A stand-out feature of India’s Covid-19 experience has been a large displacement of labour. The reverse migration of labour from urban India back to their rural homes is estimated at ~30m, or 15-20% of urban workforce. This can potentially be a drag on growth for three reasons. One, labour could be in short supply in urban India, leading to disruption in economic activity. Two, remittances from urban India could fall sharply, hurting rural demand and welfare. And three, a large surplus army of workers in rural India could impact wage setting.
We divide circular migrant labour into distress-led and aspiration-led migrants. Labourers in the first group are typically landless and in lower income brackets. Many of these labourers migrate and work in construction sites. However, aspiration-led migrants from rural India usually have some source of income back home, for instance, cultivable land, and are therefore, not among those in the lowest income bracket. Their decision to migrate to urban India is best captured by the fact that urban per-capita income is about 2.5 times the rural per-capita income.
Assuming all circular migrants in the construction sector and half of those in agriculture are distress-led, we estimate that 40% of migration in India is distress-led with the remainder aspiration-led.
Government policies such as higher MGNREGA outlays could arguably keep distressed workers back home for longer, but may not be as useful for the aspirational ones. These aspirational migrants are perhaps likely to remain in rural India only if rural wages rise relative to urban wages.
There is much excitement around rural recovery, given (1) it did not face as strict a lockdown as urban India, (2) much of the recent government stimulus has been directed towards it, and (3) monsoon rains are likely to be normal. Yet, some of this excitement could be short-lived.
By modelling rural wage growth we found the recent inflation experience (proxied by 12ma headline inflation) is the most important variable, followed by agricultural activity (proxied by GVA agriculture growth), opportunity cost of agricultural labour (proxied by construction sector growth), and finally, growth in minimum support prices.
MGNREGA may not swing the needle. The government has raised MGNREGA wages and outlays, but demand for the scheme is outpacing supply. Also, given its insignificant role in recent years, we don’t think MGNREGA will be able to push rural wages higher sustainably.
Construction slump could hurt rural wages. Rural Indians, especially the landless, have diversified into other activities, particularly construction. 70% of construction is real estate-led, and the dependence of real estate developers on NBFC funding has risen sharply in recent years (from c35% of borrowings in FY12 to ~60% in FY19). Until NBFC lending restarts, construction may not pick up fully, and rural wages may not rise again quickly either.
The combination of (1) 60% migrants being aspiration-led, thereby chasing higher wages, (2) our assessment that rural wages may not rise sustainably, and (3) early evidence that migrants are willing to return to their urban workplaces, suggests that the supply-side disruption from reverse migration may not linger long after the current agricultural sowing season is over, and assuming the peak of the pandemic is largely over by then.
Urban employers are not likely to face a prolonged shortage of labour. The situation might even be the opposite soon. Instead, the problem could lie somewhere else.
We believe India may face more of a wage problem, than a jobs one. Real wage growth had already been declining over the last few years. Our claim is supported by the following:
Compared to other countries, India has a disproportionately large share of own-account and informal workers. And, 85% of India’s labour force is employed in the unorganised sector, working in low-surplus firms, which depend far too much on daily cash flow, and do not have enough buffers to withstand large economic shocks. One such large economic shock was demonetisation, when in November 2016, ~85% of India’s currency was taken out of circulation. This is likely to have hurt the informal sector more acutely whose businesses would have dried up for a period of time given the non-availability of cash. This time around too, the improvement in labour markets between April and June has been driven more by a rise in rural jobs than in urban jobs (though some of this could just be seasonal for now). Rural job growth has been more than two times urban job growth.
In a recent HSBC global report on labour markets, Janet Henry and James Pomeroy argued that so far we have only witnessed a first round of job losses. But, over time the income effects of the pay cuts and job losses will also mean lower demand for some goods and services, especially as precautionary savings are likely to be higher once the initial pent-up demand has run its course.
They also argue that future weakness in labour markets could extend more to areas of professional and wholesale trade—those sectors immediately downstream from services such as restaurants and accommodation, which have been shuttered for months. We can see some signs of this in India already. Data from naukri.com show that after a steep fall, listings for industrial sector jobs have started to pick up, but those for services excluding IT remain relatively weak.
If this second round of labour market weakness does materialise for India, it could be led by a lack of urban job opportunities, since sectors like restaurants and accommodation are more prevalent in urban India. This may show up in the form of higher overall unemployment (jobs being lost) or higher rural employment (jobs moving to rural India), both of which could weigh on wage growth.
The importance of the recent inflation experience in driving nominal wage growth highlights the backward-looking nature of wage bargaining in India. But, the real test is a rise in real wages. That, we find, is largely driven by economic growth.
India’s post-pandemic potential growth was already falling from 7% pre-GFC to 6% pre-pandemic, and is likely to fall by 1ppt to 5% by the time the pandemic is behind us, on our estimates. Both urban and rural wage growth are likely to remain soft in the post-pandemic world, led by falling potential GDP growth.
We find three key takeaways in this report: One, concerns that labour-led supply-side disruption will pull down India’s potential growth are overblown, in our view. Although we do think potential growth will fall, it is likely to be led by a weak financial sector.
Two, weak wages could keep demand subdued. This would mean that from a labour market perspective, Covid-19 is more of a demand shock than a supply one. This could open up space for more monetary policy easing. We expect 50bps more in policy rate cuts, taking the repo rate to 3.5% by end-2020, and a prolonged period over which domestic liquidity will be kept in surplus.
Three, weak wages and growth might mean that India could get stuck in a low growth equilibrium. To offset this and ensure that things don’t spiral down further, policymakers will have an important role to play.
In particular, they may have to ensure that capital is allocated efficiently, i.e. India’s savings are employed where they are most productive, and as a result, investments keep ticking. After all, investment is the only way to increase the economy’s capacity to create well-paying jobs.
With the Covid-19 backdrop, bringing back investment growth would also involve capital reallocation. This means taking it away from sectors that are not working and redeploying it in sectors that are. Improving the Insolvency and Bankruptcy Code procedure is a key step here.
Another important step is to strengthen financial intermediation. India’s banks have become risk-averse, as a large mountain of NPLs are threatening to grow further. Reforms that tackle the reasons behind the previous build-up in bad loans are critical, such as those related to land and the power sector.
To sum it all up, we believe the supply disruption caused by reverse migration won’t last long, but demand could remain weak, requiring policy intervention.
Co-authored with Aayushi Chaudhary & Priya Mehrishi. Chaudhary is economist and Mehrishi is associate, HSBC Global Research
Edited excerpts from HSBC Global Research’s India: Job versus wages report (dated July 10)