Our economic recovery from the pandemic has been fairly steady

Indian labour market data is notoriously sketchy, but it is worth speculating whether the recovery in labour-intensive service activities will create higher incomes to support spending by households lower down in the income pyramid.
Indian labour market data is notoriously sketchy, but it is worth speculating whether the recovery in labour-intensive service activities will create higher incomes to support spending by households lower down in the income pyramid.

Summary

  • Covid damage to the labour market has been a bigger concern than the hit to India’s capital stock since the middle of 2020

The Indian economy has got off to a good start in the current financial year, expanding at 7.8% in the three months that ended in June. This was broadly in line with most forecasts by private sector economists. However, it is likely that the growth rate will ease in the coming quarters, partly because of the lingering statistical effects of the fact that the first two waves of the covid pandemic were in the April-June quarter of 2020 and 2021. The result is that economic growth this financial year could be a bit lower than what it was in the 12 months ended March 2023.

Economic activity was dominated by domestic demand, given the insipid performance of merchandise exports in recent quarters because of the slowdown in global trade. Spending on consumer goods as well as spending on new machines, infrastructure and homes has grown in strength. The latest data on quarterly gross domestic product (GDP) poses a few analytical questions that matter if one is trying to get a sense of the economic momentum for the coming quarters. This column will also later touch on a more structural question on the possible lingering effects of the economic shock from the pandemic, an issue that matters when thinking about economic performance over the medium term.

First, consumer demand seems to have held up despite higher inflation. The two lockdowns imposed in response to the pandemic had led to households accumulating a stock of excess savings—or more specifically those households that had protected incomes. This stock of excess savings acted as a buffer that has been gradually spent down once the situation normalized.

Broad-based consumer spending that goes beyond those at the top of the income pyramid will kick in only if there is adequate wage growth in the economy. Indian labour market data is notoriously sketchy, but it is worth speculating whether the recovery in labour-intensive service activities will create higher incomes to support spending by households lower down in the income pyramid. The most recent monthly data from consumer goods companies still suggests that this has not happened in adequate measure. The weak monsoon this year may also hit consumer demand.

On the other hand, capital spending has been rising as a percentage of national output, despite interest rate increases by the Reserve Bank of India in response to price pressures across the economy. It is well-known that higher capital spending has been led by infrastructure spending by the government over the past few years, a welcome fiscal pivot at this stage of the economic cycle. Residential construction has also been doing well.

There are some early signs of companies investing in new capacity, especially now that corporate balance sheets have shed the excess debt accumulated in the previous decade. A robust recovery in corporate capital spending is essential if the economy is to move to a higher growth trajectory through the rest of this decade.

Another issue that is worth speculating about is whether a higher investment rate combined with a lower current account deficit is an early indication that the savings rate is also recovering, given the basic macroeconomic accounting identity that tells us that the trade gap is equal to the investment rate minus the savings rate.

India has avoided falling into a balance of payments crisis or getting trapped in a burst of high inflation. The resilience of the Indian economy is at least partly the result of sensible steering of policy by both the finance ministry as well as the Indian central bank. Growth has been impressive compared to that in other major economies, though still inadequate to create the jobs needed for a meaningful structural transformation.

One issue that has fallen off the map as memories of the pandemic fade is the level of scarring in the economy, which is a guide to the long-term damage done by the global public health crisis. This is important since economic shocks generally have more persistent effects on developing than on developed countries. That explains why the GDP of most emerging market economies—including India—is still lower than where it would have been in case the pandemic had never happened. That is not the case with most advanced economies.

A recent paper by economists at the International Monetary Fund suggests that scarring in emerging markets has been less than initially feared, which means that positive data surprises over the past two years have not been transitory. We know from the Indian experience that large-scale capital destruction was avoided, thanks to policies ranging from government guarantees to regulatory forbearance. Firm failures have been far less than many feared, and this is reflected in the balance sheets of banks. However, there have been productivity losses because of low labour force participation rates as well as the reverse movement of labour into agriculture. The economic costs of school closures, which can hurt the quality of human capital in the future, has yet to be properly assessed in most countries.

In other words, damage to the labour market has been a bigger concern than the hit to India’s capital stock since the middle of 2020. A sustained economic acceleration led by private sector investment in new capacity is still the best bet to further reduce the medium-term effects of scarring on the Indian economy.

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