The Finance Minister needs a foolproof plan to help revive the twin cycles of capex and credit. A sustained recovery in jobs, incomes, and domestic demand depends critically on a pickup in fresh loans and investments
Faced with a historic contraction in the country’s gross domestic product (GDP) amid a tense standoff with a wealthier nuclear-armed neighbour, India’s finance minister, Nirmala Sitharaman has promised a budget like no other this year.
To stand true to her words, Sitharaman will need to address five key challenges confronting the Indian economy today. Most of them predate the covid-19 pandemic but have gained urgency after the economic devastation wreaked by the pandemic-induced lockdown. These five big challenges are somewhat intertwined with each other, and will need to be tackled in tandem to ensure a sustainable recovery.
Challenge 1: Getting domestic demand back on track
Once a favourite theme of fund-managers, India’s ‘consumption story’ had begun losing its sheen even before the pandemic-induced lockdown led to a collapse in spending. Data from the 2017-18 National Sample Survey (NSS) report on consumption spending show that real rural consumption expenditure declined between 2011-12 and 2017-18 even as it rose in urban India, leading to a fall in overall consumption numbers.
India’s national accounts statistics, which use imputed numbers to estimate consumption spending, suggest a brighter picture. However, even those numbers show a pre-pandemic slowdown in consumption before the eventual collapse in fiscal 2021.
The coming months are likely to witness a rise in consumption spending on the back of rising mobility and improving immunity. Some of the forced savings of the better-off will find its way into new spending now. Yet, beyond the initial ‘sugar-rush’ of pent-up spending, domestic demand may continue to remain weak, wrote J P Morgan economists Sajjid Chinoy and Toshi Jain in a report dated 7 January.
Among urban Indians, the propensity to spend on big-ticket items appears fairly low, a recent online survey of nearly 10,000 respondents spread across 203 cities and towns show.
Consumer confidence has been dented sharply by the pandemic and it could be a while before that reverses fully. Moreover, the loss of jobs and incomes at the bottom of the pyramid could act as a drag on domestic demand in the medium term unless the labour market heals faster, as Chinoy and Jain point out in their report.
Challenge 2: Creating decent jobs
The sustainability of the consumption revival in the coming years will ultimately hinge on India’s ability to create decent well-paying jobs. Over the past few years, the ranks of the salaried class had swelled, even if at a slow pace. The pandemic has however led to a sharp decline in the ranks of the salaried class, data from CMIE’s household surveys suggest. In fiscal 2020, 21% of the workforce surveyed were in salaried jobs. This figure fell to 17% in the September-ended quarter last year and only rose marginally to 18% in the December-ended quarter.
Many salaried people in India lack even a formal letter of appointment. Yet, such ‘regular’ jobs allow for greater consumption-smoothing than the irregular and infrequent gigs that India’s informal economy offers. The loss of such jobs has dented consumption and raised inequality at the same time.
Challenge 3: Reviving animal spirits
Job-creation at scale will require the country’s entrepreneurs to step up investments. India’s investment cycle has been moribund for several years but the past year has been an absolute washout.
As a share of India’s gross domestic product (GDP), new investments are expected to fall to 24% this fiscal, a 20-year low. The investment rate had peaked at 36% of GDP in 2007-08 and has seen a steady decline since then.
As the pile of bad loans grew in the years following the 2008 financial crash, both firms and lenders turned risk-averse in taking up new projects. Risk-aversion still remains high even as funding for new projects have dried up. If lack of clearances was the major hurdle facing new projects a decade ago, lack of financing has emerged as the big bottleneck now.
Challenge 4: Ending the credit drought
In recent years, banks have had some success in bringing down the share of toxic assets on their books but the pandemic could undo those gains. Stress test results published by the Reserve Bank of India (RBI) in its latest financial stability report suggest that the share of bad loans could shoot up to 14% by September 2021, nearly double what it was in September 2020.
At a time when credit growth has been anaemic, this would further constrain lending.
Lending can pick up steam only if banks are able to find additional capital buffers to offset the impairment of their assets. For state-owned banks, this means either infusion of equity through stake sales, or through ample budgetary provisions for recapitalization.
It is worth remembering that Indian banks are relatively under-capitalized compared to peers in other large economies. Till they remain starved of capital, they are unlikely to finance the next investment cycle.
How fast India runs on the road to recovery will depend on how well Sitharaman addresses these challenges in the upcoming budget.
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