Think Tank

The Economy: India After the Lockdown

Adit Jain, Chairman and Editorial Director, IMA India

Covid-19 is unlike any other recent crisis. So far, it has killed many more people than SARS did, and this time, the recovery will not be V-shaped but far more hesitant. Global GDP will contract by 3% or more this year, with the US economy likely to shrink by 6% and Europe by 7.5%. In sheer scale, perhaps the only viable comparison is the Spanish Flu of 1918-19, which infected 500 million people and killed 50 million, including 6 million Indians. For India specifically, the crisis will diminish both its medium-term growth prospects and global interest in the country. Businesses will need to prepare for a period of much slower growth, and will have to manage stakeholder/headquarter expectations accordingly.

A fast-rising case-load, but several reasons to be hopeful

India has managed the pandemic reasonably well…
Despite a few hiccups, India’s management of the pandemic has generally been good. The total number cases has gone past 350,000 and infection rates remain high, but the rate of doubling continues to slow, as does the R0 ratio (the number of people infected by each carrier). Maharashtra, Gujarat, Tamil Nadu and Delhi are seeing an upsurge, but Kerala and Karnataka may already be past their peaks. Moreover, India’s death rate is among the lowest in the world: 7.5/million, compared to 343 in the US, 211 in Canada, 450 in France and 580 in Spain. (China and Australia, though, are lower, at 3.2 and 4, respectively.) On current trends, infections in India may only peak around October, though this is still hugely uncertain.

India was following best practices, and it did manage to buy time for the health system to cope

Some may debate the merits of a nationwide lockdown, but it was meant to flatten the curve, and it did allow time for the country’s weak health infrastructure to be ramped up. Further, India followed what were considered at the time to be global best practices. Clearly, though, there have been issues with managing the reverse flow of migrants. Further, local implementing agencies have ended up creating major issues in supply chains and business operations. To an extent, state governments are now making matters worse by imposing strict border controls that will seriously damage their economies. Himachal Pradesh and Uttarakhand, for example, rely heavily on travel and tourism, and many of their small businesses will never recover from this blow.

The battle will be long-drawn, extending over an 18-24 month horizon

…but the economic challenges are huge
The government may have over-stated the actual size of its fiscal stimulus package. A number of the hand-outs announced were already part of the Budget equation and the fresh spending will be relatively modest. However, the NDA is looking to keep at least some of its ‘ammunition’ dry, because the next few months will be difficult. In the best case, it will be 18-24 months before a vaccine is developed and distributed on a scale wide enough to create ‘herd immunity’ (i.e., cover at least 60-70% of the population). In the meantime, the trade-off between lives (containment) and livelihoods (growth) will need to be managed very delicately.

Q1 GDP could shrink by 15%, and both demand and supply chains will take time to recover

A near-term hit to the economy
Recent economic data hint at the scale of the problem. According to the April IIP numbers, industrial output shrank by 55%. By a rough estimate, each week of lockdown costs India about Rs 2 trillion, or 1% of GDP. Factoring in 2 months of lockdown, plus the impact of job losses and salary cuts, Q1 (Apr-Jun) GDP should be expected to expected to shrink by at least 15%. Going forward, 20-30% of small businesses may not reopen and, with the enormous wealth destruction that has taken place, consumption is unlikely to recover soon. There is a strong correlation between financial wealth and consumption, in particular of big-ticket items such as cars, appliances, furniture and travel. Thus, even as industry hesitantly recovers, demand will remain suppressed for at least two years. On current trends, IMA’s projections indicate the following:

Full-year growth will be negative…

  • GDP will shrink by 5% or more in FY21, and will start to slowly recover the following year.

…the job losses will be significant…

  • In the base case, job losses will be in the region of 30-60 million . In the best case, they may be limited to 20-30 million jobs while in the worst case, they could go as high as 100 million. As a result, as many as 200 million people could slip into poverty

…inflation is likely to rise…

  • Inflation is likely to perk up . Currently, the RBI expects prices to remain subdued, largely on the assumption that demand suppression will override all other factors. However, the likelihood of further fiscal stimulus, together with constraints on the supply side, are likely to put upward pressure on inflation.

…as will banking and NBFC NPAs

  • Non-performing assets (NPAs) today are officially in the region of 8-9%, but in reality, stand at about 12-13%. In the months ahead, factoring in loans by NBFCs, the overall NPA ratio could jump to 20-24%. This will limit the financial system’s ability to lend, and banks will continue to park huge chunks of their money with the RBI.

Internal transfers will slow…

  • Remittances from the big cities to rural India and small towns will slow to a trickle in the short term, impacting consumption. Over time, however, migrants will return to the cities for work.

…and consumption will suffer

  • Consumption will fall across all groups of consumers. . Hit by job losses, salary cuts and the negative wealth effect, the middle class will refrain from non-essential spends. Meanwhile, small business owners, badly dented by the lockdown, will have huge debt obligations to service, and will hold back on spending. Clearly, the poor and the ‘newly poor’ will be among the worst affected, and will spend only on necessities.

All four balance sheets of the economy are stressed

…stressed balanced sheets…
Ultimately, the strength of any economic system is linked to four sets of balance-sheets: those of households, corporations, banks, and the government. If any two of these are stressed, while the other two remain healthy, it is possible for the economy to continue growing. In India, though, all four are currently in distress. Household disposable income growth has stalled. The government is running a huge deficit, and is in no position to do much more pump-priming. Many SMEs have been in trouble for years, and a large number of them will probably go belly-up in the next few months. Finally, even as the largest private-sector banks are in good shape, many others have seen a surge in NPAs. Fixing these issues will take years, and will require serious reforms in the land, labour and capital markets. In the meantime, economic growth will suffer.

India’s fiscal deficit is much larger than the official numbers indicate, and there is little room for additional spends

…and fiscal constraints
Officially, India’s fiscal deficit was 4.6% of GDP in FY20. In reality, it was in excess of 9.7%. The headline figures only account for the deficit of the Government of India, and exclude those of the state and municipal governments, and the debt held by PSUs and quasi-government agencies like the Food Corporation of India and the Indian Railways. Factoring all of these in, the total deficit is likely to jump towards the 15% mark this year. Unlike rich countries such as America, there are limits to the government’s borrowings – which are already ~30% higher than comparable countries in the same stage of development. In the next 12-18 months, the debt-GDP ratio could rise from ~60% to ~85%. This could trigger a ratings downgrade – India is just one notch above junk status right now – and cause economic growth to slow further. (At high levels of debt, less efficient government spending tends to crowd out private spending and investment.)

The UPA’s experience during the GFC is a cautionary tale – and one that the NDA will seek to avoid repeating

…and an underperforming manufacturing sector
The third main drag on investment and demand is India’s under-performing manufacturing and export sectors – which should have been its true engines of growth. Compared to over 50% in China, manufacturing employs barely 13% of the Indian workforce. Moreover, India now has a trade deficit with China in excess of USD 50 billion, and one that is highly skewed. While India exports raw materials like iron-ore, cotton and aluminium to China, it imports a bulk of its finished goods, including many common, low-value items from China. The fact that India imports such products from a much richer country and one with far higher labour costs, speaks poorly of its international competitiveness.

…and other emerging markets remain more attractive investment destinations as supply chains move away from China

Keeping an eye on history…
To a large degree, the government’s policy response to the crisis will be guided by India’s experience during the 2008-09 Global Financial Crisis. At the time, the UPA ramped up the deficit by as much as 4% of GDP. This propped up growth for 2 years but, thereafter, growth slumped again. More critically, inflation spiked (touching 12% and staying elevated for years), the rupee collapsed (from 43.5/USD in 2008, it dropped to 62.3 in 2014), and the fiscal deficit took years to wind down. In many ways, as the NDA is well aware, this contributed to the UPA’s electoral loss in 2014. The government understands that a serious binge would eventually drive up inflation (even if demand suppression limits the near-term impact), and cause the rupee to depreciate. It is therefore erring on the side of caution, and keeping some dry ammunition ready in case the situation worsens. Moreover, keeping in mind the political fallout of rising job losses and poverty, most new spending will be directed towards the poor. Direct support to industry will be small to non-existent. To finance the rising deficit, the government will have to use some mix of reduced expenditure (capex will be the first to go), increased borrowings, and some degree of debt monetisation.

China border tensions

India’s border tensions with China have suddenly taken a turn for the worse. Since the 1962 war, China has occupied large parts of Ladakh’s Aksai Chin region, though the two sides have largely maintained their positions along the Line of Actual Control (LAC). The LAC itself mainly follows the Johnson Line, which defines the border as agreed upon in 1947. Now, for the first time in decades, China has crossed into parts of Indian territory that were never in contention. There could be several reasons for this. First, India has constructed a new road along the LAC, allowing armoured vehicles to move there quickly. Second, India has built air-strips in the region, permitting its fighter jets to land there. Third, China is uncomfortable with India joining the bandwagon of nations opposed to China’s rise. India has sided with the West by joining the Quad and is also supporting the investigation into the origins of Covid-19. China’s actions are in line with its long-running ‘salami’ tactics, under which it grabs a bit of territory, waits for a (non) response, and then grabs a bit more.

In the past, India has tended to segregate economic and military issues, to an extent where different arms of the state acted at odds with each other. For instance, the GoI awarded a Rs 1,200 crore contract to the Shanghai Tunnelling Company, for a bid only slightly lower than one offered by L&T. BSNL contracted a Chinese firm to store its data on the cloud. From all indications, the response to the latest provocation will be stronger and more ‘wholesome’, mixing trade and investment issues with geopolitical ones. India’s huge trade deficit with China – currently in the region of USD 60 billion – will be carefully examined. In all likelihood, India will review, and possibly cancel, a range of existing contracts with Chinese companies.

Top managers will need to contend with several paradigm shifts in the business environment

Managing in a ‘new normal’
Looking ahead, businesses will need to contend with several shifts in the broader environment. Specific to Asia, China’s tightening grip on Hong Kong will cause the city-state to lose its place as a global financial centre, and many firms will shift their regional offices to Singapore or Shanghai. Global supply chains will transform from hyper-efficient and globally connected ‘just in time’ systems, to ones that are more local and less efficient, but more resilient. Businesses will also increasingly move out of China – to places like Vietnam – and this ‘decoupling’ will remain a serious issue in the medium term. All companies, including B2Bs, will become more digitally-savvy and e-Commerce-driven in terms of both process and structures. Everyone will need to become more agile and proactive – annual planning will give way to shorter time-frames. Finally, organisational cultures and leadership styles will change – from command-driven to networked. There will give more latitude for down-the-line decision-making, more work-from-home, and much less travel.