As India continues to fight the second wave, the debate is on how its impact is different from the first one. Meanwhile, number of FY22 growth downgrades have increased recently. In this context, we take a step back and look at some of the noteworthy factors which could define India’s short and medium term growth trajectories. The endeavor is to ask critical questions about the health of various economic agents and thus growth drivers.
The haze
Differences in the impact of the second wave, some of them well appreciated, include the weaker mobility-activity link (as households and corporates are better prepared) and less stringent policy restrictions this time making y-o-y numbers look better, despite the sequential deterioration in high-frequency indicators. Focus is more on the hazy bits right ahead – peak of the ongoing wave, progress in vaccinations by year-end and pent-up demand (timing, duration, nature and quantum). However, haze around even the real-time situation of employment, wages, bank NPAs and general health of MSMEs and the informal sector (which have been disproportionately hit and hence the K-shaped recovery witnessed) is thicker as timely and detailed data is not available. Despite these challenges to economic assessment, there are key questions one needs to consider when evaluating the impact of the ongoing wave in the near term and on the economy’s potential growth.
What could be the economic impact of the likely hit to household income?
Household balance sheets were weak when Covid hit – income growth had slowed, NBFC-leveraged consumption cycle had ended and meaningful deleveraging had started in FY20. Impact from the two waves and only a mild direct income support would have hit them further. News flow suggests higher number of infections among rural and middle-class urban households this time, and state lockdowns have gathered strength. All this could potentially dampen the pent-up demand vs. last year as health expenditure has likely risen and people could be warier of health risks after witnessing the magnitude of the second wave and some states preparing for the third wave. This also implies some of this demand may surface only after vaccination reaches a critical mass, say early 2022. Moreover, given above factors and the absence of any wealth effect as in advanced economies (e.g. US stock prices have risen and a larger share of population is invested in stocks), it is likely a good part of additional household savings does not immediately translate into consumption. Beyond FY22, this matters as private consumption is 60% of GDP and household savings is 20% of GDP (of the overall savings of ~31% of GDP). Overall, households are likely to emerge from all this with implications for both ability and willingness to consume.
What is different about the rural economy this time?
Pre-Covid, nominal rural wage growth was weak and real growth was negative from Sep19. After last year’s labour migration to rural settled, it is rising gradually but driven only by non-core-agri wages (animal husbandry, fishing, etc.) as growth in non-agri wages is flat and that in core-agri wages has fallen. This points to the largely uneven labour distribution and wage growth recovery. With the Kharif crop season approaching, monsoon rainfall (IMD forecast is ‘normal’), progress in sowing and its conversion into harvesting is critical. However, we have to recognize 50% of rural households are non-agri and a large share of agri households earn a good part of their income from non-agri sources. Rural population employed by MGNREGA is also low. So, agri & non-agri progress alongside urban demand matters but, higher rural infections this time increases the risks for the rural economy which has a higher marginal propensity to consume vs. the urban economy.
How would corporates behave?
Unlike last year, when margins were more than preserved by cutting employee and raw material expenses, this year could face pressure from sharp rise in input costs, lesser space & avenues for incremental cost cuts and price hike being overdue in some sectors. On aggregate, weaker demand could potentially dampen price hikes. Price changes will depend on product & sector dynamics too but it can be nuanced, especially for service providers. Recent retail price momentum in services has mainly been higher in health (higher demand for medicines), household services (possibly lower supply of labour) and transportation & communication (residual demand possibly has lower price elasticity as suggested by higher bus/railway/boat/air fares; higher internet & mobile prices). This could at best only partially offset the fall in quantity consumed. Corporate debt and profit growth trajectories would be crucial.
Consequently, supply of risk capital in the system, which was again low before Covid hit, would matter as lending decisions to households and corporates will entail evaluation of their economic health based on the above factors. The real NPA situation is unclear as of now but will be another major aspect to consider.
Produce to export?
With capacity utilisation now lower and the likely hit to household demand, investment growth could remain slow. Can exports get to the rescue? The likely immediate support for exports is straightforward – reopening, progress in vaccination and higher fiscal & monetary support elsewhere. As per the IMF, direct fiscal support from Jan20 is 25.5% of GDP in the US, 16.4% for advanced economies and 9.2% for the world. However, there are some offsets even in the near term – switch in consumption from goods to non-traded services as economies reopen, hit to Asia’s production of automobiles and consumer electronics from the ongoing semiconductor shortage and rise in Covid infections (e.g. Singapore and Taiwan have recently reinstated certain restrictions as cases started to rise again). Covid related unemployment insurance in US expires early September this year and further stimulus is over a longer term and likely partially funded through tax increases. However, recently reported labour shortages and wage pressures need to be closely watched, particularly post September.
Beyond the next few quarters, support for exports could be milder. Impetus to global trade of the kind after China joined WTO in 2003 might not repeat as it seems committed to its new ‘Dual Circulation’ strategy of focusing more on domestic demand over exports and pursuing a path of measured monetary growth to address high economic leverage in its quest for sustainable growth. Ongoing trend of de-globalisation and that many factories which recently shifted from China moved elsewhere is noteworthy. However, likely lower-for-longer interest rates in US (and other advanced economies) as Fed implements its new average inflation targeting framework, responds only to actual and not expected data and now focuses more on labour market recovery augur well. PLI schemes, if successful and with more rollouts, will also be important.
What could drive growth?
Cyclical growth tailwinds like the pending global inventory re-stocking after the drawdown in 2019, banks’ recognition of corporate NPAs being over the hill and a recovery in the real estate sector, a major nation-wide employer, are definitely positive signs but not devoid of caveats. If lack of visibility in consumer demand persists, it can percolate through the economy and influence investment and lending decisions. Particularly, even if the K-shaped recovery witnessed gets exacerbated and/or stretched, overall demand will be meaningfully hit as the two legs of the ‘K’ don’t work in silos.
Essentially, we need recovery and a growth-cycle in employment and wages. This will provide demand-visibility to corporates to increase capacity utilisation and make fresh investments, which may not materially move otherwise. While consumption support may be necessary in the near-term, it will have implications for the current account deficit if overdone. In either case, it will not usher in a growth-cycle to support potential GDP. Given the current global outlook beyond reopening & stimulus, it could be difficult for exports alone to drive the growth engine. India also imports quite a bit for re-exports, given its position in the global supply chain and the value addition it offers, which would partly offset any thrust from exports. Modifications to trade policies and higher competitiveness also have to lead export opportunities.
Summary
The immediate economic impact of the second wave is likely milder. While uncertainty prevails for the near term, the haze around employment, wages and MSMEs continues to be thicker. Higher cases in rural India, which is not just about agri, and factors impacting household income suggest less support for pent up demand and medium-term consumption. For corporates, this would influence pricing and investment behavior. For financial institutions, this and the NPA situation would determine provision of risk capital. While exports could immediately get a boost, most factors can fade beyond the next few quarters. Cyclical growth tailwinds still hold but demand is crucial here too and a K-shaped recovery will not be sufficient. The pandemic’s path, policy moves, vaccination progress and efficacy, domestically and globally, would obviously shape the factors discussed and the growth trajectory. However, we still need a cycle of employment and wage growth.
Abbreviations: NPA – Non-Performing Asset, MSME – Micro, Small & Medium Enterprise, NBFC – Non-Banking Financial Company, GDP – Gross Domestic Product, IMD – India Meteorological Department, MGNREGA – Mahatma Gandhi National Rural Employment Guarantee Act, IMF – International Monetary Fund, WTO – World Trade Organization, PLI – Production Linked Incentive
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