By Pranjul Bhandari, Aayushi Chaudary and Priya Mehrishi
Good news first. India’s second pandemic wave could show the first signs of a peak. Recoveries are increasing and the positivity ratio decreases in states that have imposed early lockouts. Yet now is not the time for complacency. The overall number of new cases as well as the nationwide positivity rates remain consistently high. And some of the economic costs of this wave could survive local lockdowns.
Roll back to 2020. A strict national lockdown resulted in a sharp contraction in growth (GVA fell 23% q / q in the April-June quarter). But this was followed by a strong increase (of 19% q / q over the July-September quarter), driven by various factors, namely pent-up demand from consumers, resupply of demand from sellers and gains from formalization. by producers.
The dominant narrative this time around is that in an effort to contain the economic cost of the pandemic wave, a nationwide lockdown has been avoided. As such, even with local lockdowns being imposed as the pandemic spreads, the overall cost is expected to be only a fraction of what India experienced last year. Indeed, economic indicators such as PMI indices and GST collections are holding up pretty well this time around. And as the wave eases, the recovery that sets in for the next quarter (July-September), should be further strengthened by higher vaccination rates.
While this account isn’t entirely wrong, we think it may be too simplistic. Understanding the different dimensions on which the second wave differs from the first is essential to truly understand its economic cost and the path to recovery. The second wave differs from the first in four ways, each fueling uncertainty.
First, phased state and local level lockdowns may seem less stringent than a national lockdown, but they come with enormous uncertainty about when and impact. What state is the next one in? How long will the lockdown be extended? Will interstate commerce be affected? And will subsequent waves bring back such lockdowns?
Second, the urban spread of the second wave is more concentrated among better-off households this time around. Data from the Mumbai Municipal Corporation, for example, shows that 34% of cases involved buildings in the first wave, up from 90% this time around. To the extent that affluent households further stimulate consumer demand, weak sentiment among them could keep pent-up demand subdued.
Third, the disease shows signs of spreading in the rural center, more than during the first wave. For example, rural India accounted for 21.1% of the country’s pandemic cases in April 2020 and 44.1% in April 2021.
Fourth, with rising global commodity prices, domestic manufacturers are struggling with declining margins. Low commodity prices and urgent cost reductions helped companies weather the first wave. But this time around, businesses can find themselves stuck between a rock and a hard place.
On the one hand, global commodity prices are on the rise and it is difficult to reduce emergency costs for a second year in a row. On the other hand, domestic demand is vulnerable and the passing-on of higher prices to consumers may weaken demand further. So far, companies have taken it on the chin, that is, on their profit margins. But is it sustainable? Putting all of this together, we expect GVA to grow 7% year-on-year in FY22 (versus our forecast of 10.2% earlier). The GDP growth forecast is 8% year-on-year in FY22 (up from 11.2% earlier).
The government’s budget plan to repay food subsidy arrears from years spent at the CFI is a good step, but will end up skewing the GDP growth figures, especially because the CFI follows ‘accrual accounting’ while the government follows “cash accounting”. We estimate an overestimation of GDP growth of c1 percentage point (ppt) in FY22 and an overestimation of c0.5ppt in FY23, which are incorporated into our GDP forecast.
For FY 23, we forecast GVA growth of 5.3% (5.1% earlier) and GDP growth of 6% (5.8% earlier). Even though we expect the country to return to pre-pandemic GDP levels by the end of 2021, it will likely remain 12% below the pre-pandemic trajectory, even by FY 23. A few months ago, before the second wave hit, we were concerned about the scars the first wave of the pandemic would leave behind – a weak financial system and growing inequality.
We then estimated that these two could lower India’s potential growth from 1 point of 6% before the pandemic to 5% after.
Currently, the markets seem quite relaxed in the face of the double balance sheet problem. Banks’ capital buffers have improved in recent quarters. After peaking in March 2018, bank NPAs have also followed a downward trajectory. Some corporate deleveraging has occurred, particularly with the continued rebound in equity markets. But it could get worse from here. NPAs are already double the long-term average and typically increase a year or two after a downturn.
Industrial credit is weak and real personal loan growth has also slowed. Bank investments exceed credit spending. All of these, in a sense, are signs of rising risk aversion in the banking industry. If banks become increasingly risk averse, this could result in insufficient loan growth, which means there is not enough funds available, which could weigh on growth potential in the medium term. .
Large publicly traded companies have benefited from the pandemic and the resulting “formalization” has clearly manifested itself in corporate results. Given the significant efficiency gains associated with the formal sector, it is no surprise that stock markets continue to cheer. But, if ‘formalization’ occurs at the expense of the failure of small informal enterprises, then the disruption of the informal sector may strain demand in later periods, reducing potential growth over time – 85% of the labor force. and 50% of the economy is informal.
It is also possible that the formalization will fade over time. This happened during demonetization. Our study of business performance shows that since the ecosystem hasn’t changed much, the informal sector has made a comeback. And in this case, the efficiency gains associated with formalization have dissipated.
The constructive way to think about it is to differentiate between “forced” and “organic” formalization. Formalization that comes only on the back of external pressures or that leads to deep distress in the informal sector, can either reduce potential growth or be unsustainable. In contrast, the formalization that occurs as a result of policy changes that help informal enterprises grow over time to become larger formal sector enterprises is more sustainable. Can India move from forced formalization to desirable formalization?
The immediate measure for the economy is to speed up vaccination rates. We would have to go from 1.9 million bites / day to 5 million euros / day to vaccinate 50% of the population by the end of 2021. Beyond that, we see at least four key political steps:
The IBC needs to be strengthened. It needs to be overhauled – in particular, the incentive structure between debtors, creditors and the courts – for this important institution to become effective.
There is reason to remain generous with NREGA, where the demand for labor exceeds the supply. India does not have an equivalent urban social protection scheme. The design and implementation of an urban social protection program could provide reliable support.
While the Centre’s focus on capital spending in the February budget is a big plus, divestment should be accelerated in order to make it achievable.
Production incentive programs (PLIs) that increase investment and jobs generate a lot of enthusiasm. While it can provide an initial boost, sustainable growth requires improvements in the ease of doing business, an R&D culture, and a move away from import tariffs.
The government has increased import tariffs on a wide variety of products in recent years. Higher import tariffs can increase economy-wide production costs, or even constitute a tax on exports. Past attempts at import substitution – export promotion, have failed.
Respectively, Chief Economist (India), Economist and Partner, HSBC Securities and Capital Markets (India) Private.
Opinions are personal.
Edited excerpts from HSBC Global Research India’s Cost of Uncertainty report, May 13