BackThe second wave is different and its uncertainty could be costly
Covid’s impact this year will differ from that of 2020 and we need a policy programme designed to heal the economy’s scars
PremiumThe good news first. India’s covid surge is showing its first signs of peaking. But with daily new cases still elevated, this is not a time for complacency. Even on the economic front, we worry that the damage done by this wave of infections could far outweigh the costs of lockdowns. Let me explain. This second wave is different from the first one last year in four ways. And each of these is stoking uncertainty, which in turn could hurt the economic recovery.
One, a patchwork of local lockdowns may feel less stringent than a national one, but raises uncertainty around timing and impact. Which state is going to be next? How long will the lockdown be extended for? Will interstate trade be hurt? And will subsequent waves lead to further lockdowns? Two, the urban spread of the second wave is more concentrated among relatively affluent households this time. Data from Mumbai’s municipal corporation, for instance, shows that during the first wave, 34% of cases were in residential buildings (with the rest in slums), compared with 90% this time around. To the extent that better-off households generally spend more than others, this could keep a recovery subdued.
Three, the disease is showing signs of spreading into the villages, more so than during the first wave. Rural India accounted for 21% of the country’s cases in April 2020, and 44% in April 2021. Growth there was relatively robust in the first wave, as villagers were exempt from much of the lockdown. But, if the disease spreads to the rural heartlands, it could mean a new cloud of uncertainty. Will the state of healthcare facilities be good enough? Will rural production and demand hold up? Four, profit margins are falling amid rising global commodity prices, with companies unable to make emergency cost cuts for the second year in a row. Passing on higher prices to consumers risks denting demand further. So far, firms have been taking falling profits on the chin, but is this sustainable? As explained by Keynes long ago, and borne out by research since, it is not just economic forecasts but confidence in forecasts that impacts economic activity. Even before the Indian economy had fully recovered from the first wave, the second wave struck, with clear differences that could result in enhanced uncertainty, lasting beyond the duration of lockdowns.
Having said that, there are some silver linings on the horizon. Global growth remains strong, capital markets are buoyant, and firms have learnt to function amid the new normal of lockdowns. To quantify the true economic cost of the second wave, these positives need to be netted off against the negatives.
Putting it all together, our analysis indicates that the April to June quarter will be hard hit by the lockdown, shrinking 13% from the quarter before, although that’s about half the contraction in the same quarter last year. The rebound in the July to September quarter could be a tad soft amid the weight of new uncertainties. However, exuberance is likely to come in the October to March period, when the vaccinated population should reach critical mass. Bringing all this together, gross value added (GVA), our preferred measure of economic activity, could grow 7% in 2021-22, and corresponding gross domestic product (GDP) growth is likely to be 8%. This is below the consensus of 10.3% GDP growth for the year.
But what thereafter? Even while India was benefiting from a cyclical recovery a couple of months ago, before the second wave struck, we were concerned about the scars that the first wave of the pandemic would leave behind—a weak financial system and rising inequality. If bad loans at banks rise over time, banks could become risk averse, hurting credit and GDP growth. The country’s informal sector makes up 85% of the labour force. Disruption there can weigh on demand. We had estimated that these two factors, together, could drag down India’s post-pandemic potential growth by 1 percentage point to 5% per year. And now with the new wave, we are concerned that the scars may deepen further. Thankfully, potential growth is not static. It can fall, but it can also rise. And, encouragingly for an emerging economy like India, reforms can play a significant role. We see at least four key policy steps the government can take.
One, strengthen the Insolvency and Bankruptcy Code (IBC): To overcome banking sector strains that could otherwise pile up, we believe the IBC must be strengthened. In particular, the incentive structure for resolving bad debts across borrowers, creditors and the courts needs to be revisited.
Two, continue with social welfare spending: To ensure that the pandemic does not lead to a permanent fall in the incomes of informal-sector workers, we think social welfare schemes need to be maintained for longer. At least, there is a case for remaining generous with India’s main rural scheme under the Mahatma Gandhi National Rural Employment Guarantee Act, where demand for work is outstripping supply.
Three, get disinvestment done: While the central government’s focus on capital expenditure in the February budget was a big positive for the economy, stake sales would need to be fast-tracked to make it achievable, especially with the second wave threatening to lower tax revenues.
Four, move from an import-substitution mindset to export promotion: There is much excitement about the production-linked incentive schemes raising capital expenditure and jobs. While it can give an initial push, sustainable growth requires many other changes. The government has been raising import tariffs on a wide variety of goods over the last few years, which we worry can work as a tax on exports by raising the cost of production (as observed, for example, in the 1970s).
The covid pandemic will leave behind some scars, but with careful steps, India can hope to heal them over time.
Pranjul Bhandari is chief India economist at HSBC
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