First, the good news. Although India experienced one of the largest growth contractions among emerging markets in 2020, the larger decline sets stage for a larger bounce in 2021. The ‘inner’ V-shaped normalisation has so far been mobility-driven, with an opportunistic confluence of reduced cases, relaxed lockdowns and pent-up demand. High-frequency data suggest a firmer recovery in consumption, investment and industry indicators while the services sector has lagged.
However, in the near term, the faster-than-expected normalisation path could face disruptions. The festive season leaves in its aftermath a renewed pandemic threat and a loss of the consumption boost. The former is already playing out, with a number of states now reinstating lockdown restrictions. Also, labour markets have yet to fully recover, and the strong pickup in formal sector indicators may not be capturing the massive pain in the informal economy. Additionally, we remain sceptical that GoI’s Rs 12 trillion of market borrowing for FY2020-21 adequately accounts for the sharp decline in revenues.
We are already seeing the government paradoxically having to axe expenditure to get the proverbial coat to fit the cloth, which is adversely weighing on growth. Thus, after the sharp rebound in activity so far, the sequential pace is likely to be slightly softer in coming months.
Looking into FY2021-22, three key themes may emerge. First, GoI has made good progress on pre-sourcing vaccine doses, and it expects to inoculate 400-500 million people by July 2021. This should create a ‘vaccine pivot’ in the second half of next year. No doubt there are distribution challenges, but as coverage increases, a spurt in growth of contact-intensive services such as travel and hospitality, which rely on broader public confidence to reattain full potential, should be witnessed.
Second, easy financial conditions and a reduced fear factor should boost consumption growth. In response to the humungous 250 basis points (bps) of policy easing delivered by the Reserve Bank of India (RBI) so far, real lending rates have sharply fallen after staying largely range-bound for the past five years. This could eventually lead to an inflection in the credit cycle and bring some relief to interest-sensitive sectors, particularly consumption of durable and semi-durable goods, which account for about 11% of GDP. However, lower incomes and sluggish job creation remain an overhang.
Third, a stronger global economy in 2021 will be an added tailwind. While there should be uncertainty in the first half given the revival of Covid-19 cases globally, developed economies should also benefit from a wider availability of vaccines in mid-2021, which should boost consumer and business confidence. This, in turn, bodes well for domestic exports and the manufacturing sector.
However, the economy faces considerable bottlenecks. India’s pre-pandemic crisis involving a triad of weak balance sheets — of corporates, banks and shadow banks — are now skeletons temporarily hidden inside the cupboards of moratoria, credit guarantee schemes and procedural delays to the recognition of bad loans. Some of the stressed assets may turn into nonperforming loans with a lag. Household balance sheets are relatively sound. But in the absence of income growth, the debt service burden is likely to increase, and the unsecured retail loan segment is under pressure.
This, in turn, risks prolonging the slump in the capital expenditure cycle, where current new projects primarily involve the transportation sector, which in real terms accounts for less than 8% of fixed investment GDP. The chasm between funding costs of the ‘haves’ and ‘have-nots’ in the financial and real economies is likely to remain wide, as liquidity naturally gravitates towards stronger balance sheets, leaving the weaker ones even weaker, and endangering financial stability as a whole. The risk of financial sector ‘accidents’ involving banks and financial intermediaries remains non-trivial.
Finally, the policy space is likely ephemeral. Despite the growth recovery, the narrow revenue base implies GoI will remain saddled with the Hobson’s choice between fiscal consolidation and fiscal activism. Elevated inflation is also constraining conventional monetary policy space. In the unconventional realm, as we move through 2021, concerns could also emerge over risks from having financial conditions too easy for too long.
GoI’s recent factor market reforms, while positive, need to be underpinned by a robust last-mile delivery. Overall, the pace of normalisation has been swifter than expected and a cyclical recovery may ensue. But the durability of the growth cycle remains shaky. Consequently, while it might have been a double-barrel V on the way down, the way up is likely to be far less synchronised.
(Varma is chief economist, India & Asia ex-Japan, and Nandi is India economist, Nomura.)