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As much we would like to forget 2020, it is unlikely we will anytime soon. The covid vaccine will, hopefully, silence the disease eventually, but it cannot erase all the scars.

For instance, the massive stimulus across the world has inflated government debt and central bank balance sheets to abnormal levels. Normalizing this would in itself be a big challenge and can be quite disruptive, with markets likely to be roiled. That’s just one of several problems ahead of us.

There is some good news on the covid front and economic indicators have started flashing green. This has triggered gross domestic product (GDP) growth upgrades for India. CRISIL, too, sees India’s real GDP contracting 7.7% this fiscal year, compared with a contraction of 9% forecast in September.

Interestingly, as with the hit to India’s economy, the recovery in its different parts has not been synchronized—it’s a two-speed recovery that we are seeing.

In the first quarter of this fiscal, for instance, manufacturing GDP contracted 39% versus a 21% contraction in services. This was largely because manufacturing came to a sudden halt following the “world’s most stringent" lockdown, while the services sector found support from essential services. But in the second quarter, manufacturing logged a growth of 0.6%, while services continued to languish.

This trend is likely to continue into the second half of this fiscal year, as contact-based services will remain subdued due to residual anxieties even after vaccination begins. Incidentally, this pattern has been seen in Europe as well, where services are being hit harder by the recent lockdown imposed due to a strong second wave.

The second dichotomy that is more apparent in India than elsewhere is between rural and urban economy. The rural economy accounts for almost half of India’s GDP and has done better than its urban counterpart, as reflected in the better performance of sectors with a rural footprint, such as tractors, two-wheelers, fertilizers and agrochemicals.

There are three reasons for this. First, agricultural activity has continued largely unhindered due to its nature, normal monsoons, and lower penetration of covid in rural areas compared with urban pockets. The urban population density is higher than rural, which slows the spread of infections in rural areas. Currently, rural India accounts for over 65% of the population but less than 55% of covid cases.

Second, government support is tilted towards the rural economy, with 50,000 crore additional resources for the Mahatma Gandhi National Rural Employment Guarantee Act scheme and 39,000 crore disbursed under PM-Kisan this year. No such scheme is available for the urban poor.

Third, the structure of the non-agriculture rural economy makes it more resilient. While the rural economy contributes 51% to manufacturing GDP, its share in services (other than public administration and defence and utilities) is only about 26%. So, a harder hit to services creates more downside for the urban economy than rural.

The equity markets and the economy have taken divergent paths, too. Low interest rates and abundant liquidity have inflated markets, even though the economy is in a technical recession.

Smaller firms appear to be hit much harder by the pandemic. So, the next round of non-performing assets is more likely to originate from the micro, small and medium enterprises segment than from larger corporates, which are better placed from a solvency perspective. The earlier round of increase, incidentally, was triggered by larger firms.

We expect India’s real GDP growth to bounce back to 10% next fiscal, riding primarily on a low statistical base. There is further upside if covid lies low, as it has for the past 2-3 months, the government opens its purse strings to support demand, and monetary easing reaches the broader economy.

Worryingly, monetary policy space is getting crimped. One of the biggest surprises and policy challenges this year has been an unfettered uptrend in inflation—it’s at its highest since 2016, when inflation targeting was implemented—in a year of economic contraction.

This restricts the ability of the Reserve Bank of India (RBI) to support the economy through rate cuts. Unlike the West, India still has conventional-policy headroom. However, inflation comes in the way. We expect inflation to average at 6.4% this fiscal—40 basis points above the higher bound of RBI’s target range.

That said, RBI has decided to look through inflation in view of the deep hit the economy has taken, and has guided markets on maintaining an accommodative stance into next year as well.

Meanwhile, there is some way to go before RBI’s monetary easing percolates to the broader economy. Bank credit growth remains weak due to low demand from creditworthy borrowers, and high risk aversion when it comes to lending to smaller and to less creditworthy ones. Fiscal policy support will be critical for this too, as the government will have to step in to support these sectors and/or incentivize job creation to reduce risks emanating from them.

So, all eyes on the next round of fiscal stimulus and on the Union budget to be presented on 1 February.

Dharmakirti Joshi is chief economist, CRISIL Ltd

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