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Indian economy & Covid-19: Risk aversion may be higher in 2nd wave

Dr Rajeswari Sengupta, Assistant Professor at IGIDR, opines that trend of increased demand from international markets for merchandise goods will continue at least for one more year as a lot of demand for goods is driven by the shift to ‘work from home’ models which includes kind of commodities that India exports. However, she also opines that recovery of the economy itself may happen in stops and starts depending on the recurrence of a 3rd or 4th wave and/or mutations of the virus. 

Prof Rajeswari Sengupta_TPCI

IBT: Despite the surge in cases, India’s merchandise exports have shown robust growth in April’ 2021. What are the expectations for the sustainability of this growth?

Prof Rajeswari Sengupta: Currently the world is experiencing a commodity price boom owing to a resurgence in demand from the recovering economies of the US, China etc. Many of our exports are commodities; as a result some of the increase in export values that is showing up would be due to the rise in commodity prices. 

In general, owing to the imposition of lockdowns and mobility restrictions in countries affected by the pandemic, demand has shifted from services to goods, also causing a rise in commodity prices. If this continues then this will lead to a decent amount of growth in our merchandise exports. If on the other hand this gets unwound as the developed countries come out of the lockdowns, services demand may go up again and commodity prices will collapse, also resulting in a decline in demand for our merchandise exports. 

My sense is that this trend of increased demand for merchandise goods will continue at least for one more year. A lot of this demand for goods is driven by the shift to ‘work-from-home’ models, which is likely to continue for a while in most countries that are on the verge of an economic recovery owing to accelerated vaccinations. There will be increased demand for items that facilitate ‘work from home’ such as furniture, electronics, computers; with people moving away from cities, demand for cars and car parts has gone up; also demand for steel, chemicals, minerals etc. All these benefit India because these are the kinds of commodities that we export. 

In other words, the resurgence of demand in the West is linked to the kind of goods that India produces which is good news for us and I think this will continue for at least one more year. 

It is however uncertain whether this trend of increased demand for merchandise exports will last longer than a year. Exporting firms will need to invest in significant amount of capacity building if they predict that this demand will last beyond the next year, but this is a big unknown. Once life returns to normalcy gradually, and mobility restrictions are lifted in a majority of the countries, demand for services will go up again and at that point, demand for merchandise exports might fall. 

A deterrent in this context that is worth noting is the increase in import tariffs imposed by India in recent times as part of the “Make in India” or “Atmanirbhar” initiatives. While India is well placed over the next one year to benefit from the surge in demand for merchandise exports and ride this wave in international trade that has already begun, increased import tariffs may disrupt this opportunity that has arisen.

As a result of these tariffs, and given that many of the inputs used in our merchandise exports are imported, our exports may lose their competitiveness in the global trade landscape, especially to competitors in Asia. The need of the hour is to lower import tariffs, move away from protectionism and let the exporters take full advantage of the resurgence in global demand. 

A third unknown factor is the movement in the exchange rate. Any depreciation of the Indian Rupee vis- a-vis the US Dollar will help our merchandise exports. Given the current global landscape, with the US economy exhibiting signs of a fast and strong recovery and the Indian economy still in the throes of the pandemic, there is a good possibility that the Rupee will depreciate in the next few months as foreign capital leaves Indian financial markets for the US; Indian exporters will benefit.

IBT: What sectors are showing/expected to show resilience during the second wave of COVID-19? Why? Conversely, which sectors are in urgent need of support?

Prof Rajeswari Sengupta: The usual suspects such as hospitality industry, travel and tourism, aviation, restaurants, entertainment, commercial real estate, small transport operators, etc are likely to bear the brunt of the second wave as they did in the first wave; as also will all categories of services that entail interaction with the customers. 

In nearly all sectors, MSMEs are likely to suffer significantly more. Large firms might be able to better adapt to the second wave, having learnt from their experience of the first wave, and also because they have deeper and better financial access. The FMCG sector may also get badly hit this time, if the pandemic strengthens its grip over rural areas, thereby causing economic distress.  

Having said that, the initial conditions this time around would be critical for all firms and sectors in their quest for survival. In the first wave of 2020, firms responded by laying off workers, running down their cash balances and shutting down marginal, unprofitable outlets etc. They cannot repeat the same strategy now. In that sense, the second wave of 2021 may be more damaging for a lot of firms. MSMEs in particular will suffer because they struggle to obtain formal financing even in normal times and are perhaps less resilient today because of the damage already faced in the first wave. 

The uncertainty associated with the second wave is also greater and the risk aversion is likely to be higher too, which means even after regional lockdowns are relaxed and we are well beyond the peak of the second wave in most states, demand may not revive to the same extent it did in 2020. Discretionary spending is likely to stay subdued. Consumer as well as investor confidence may take much longer to recover depending on the pace of vaccination,. This implies that only firms with deep financial pockets will emerge as survivors and those that don’t may have to shut down. In summary, I think the MSME sector needs the maximum amount of support to survive this economic crisis. 

IBT: According to CMIE data, India’s employment rate fell to 36.79% in April’ 2021. How is rising unemployment going to impact the recovery and what can the government and industry do to address the issue?

Prof Rajeswari Sengupta: Unemployment in May has gone up by even more from 7.97% in April to 10.8% (rough estimate based on data available so far from CMIE). In the latest week, ending in May 23, it was at 14.7%. Urban unemployment has gone up from 9.8% in April to roughly 13% in May. While this is much lower than May 2020 when urban unemployment had gone up to 23.1% and overall unemployment had gone up to 21.7%, we have to keep in mind that the drastic rise in unemployment in the summer of 2020 was due to a stringent, nationwide lockdown imposed by the central government.

This time around, the lockdowns are regional and hence more scattered and less restrictive in comparison. Also many enterprises are better prepared now to deal with lockdowns. The rise in unemployment inspite of these factors is particularly worrisome, because the labour force participation rate has not gone up simultaneously; i.e. unemployment is rising not because new people are looking for jobs but because existing workers are losing jobs. 

This rise in unemployment on account of the second wave may take much longer to get corrected than last year. Economic agents are likely to proceed with greater caution this time around due to widespread fear of a 3rd or 4th wave, substantial delays in universal vaccination and also threats from potential mutations of the virus which become more real the longer majority of the population stays unvaccinated.  

Let’s say if the real GDP growth for this year is 5%, then assuming the GDP contraction of last year was 10%, at the end of 2022 the economy is still at a net -5% growth rate; i.e. it is still not at the pre-pandemic level of economic activity. This will be very damaging for job creation. If hypothetically the economy grows at say 7% in 2023, this means it is only 2% above the 2019 level of economic activity. This translates to almost 3 years of lost growth which is a tough situation to be in.

Therefore, we will reach the pre-pandemic level of economic activity very slowly and the longer it takes, the worse will be the pace of subsequent growth and in the process, potential growth rate of the economy will go down. This means that there will be a downward shift of trend growth rate as a result of which overall unemployment in the economy could remain high for a long period of time. Revival of confidence in the private sector is a crucial factor in this regard.

IBT: Since rural areas are among the worst hit in the second wave, what extent of damage is possible for the agriculture sector? What support would be required by farmers?

Prof Rajeswari Sengupta: Agriculture today is a relatively small percentage of GDP. However if a large fraction of the rural areas gets affected by the pandemic then yes, agricultural production will get adversely affected over the next 4-5 weeks. Kharif crops are usually sown in the May-June period and if that gets disrupted due to the pandemic in a severe manner, then this could lead to supply shortages down the road. It all depends on the extent of severity of the pandemic in agricultural regions. 

It is worthwhile to note in this context that rural areas do not have the same degree of population density or concentration of dwellings compared to the cities and towns where the second wave became severe. This feature by itself may ensure that rural areas are not as badly impacted as the urban locations. 

A major source of income in rural areas is non-farm activity. This might get hampered as a result of the rising infections. This may show up in reduced demand for goods (e.g. two wheelers, FMCG products etc). A reasonably strong shock absorber so far has been the Mahatma Gandhi National Rural Employment Government Act (MGNREGA) program. If the pandemic strengthens its grip over rural areas, then MGNREGA may also cease to work effectively; so this is something we have to watch out for. 

I do not think at this stage the government can do much to provide relief; fiscally it is in a very tight situation. What it can do to help is to expedite the vaccination process as much as possible. I am not sure handing over the responsibility to the states who themselves are financially constrained now is a good idea. For example the Western countries now have a big surplus of vaccines; the government should start engaging in deft negotiations to procure huge supplies from abroad.

Procurement of vaccines from foreign suppliers must be handled by the central government and not left to the states. The production capacity of our domestic manufacturers at this stage is limited, which means that we have to start prioritising import of vaccines. 

IBT: What can the RBI do for the liquidity-constrained SMEs in particular?

Prof Rajeswari Sengupta: We have to remember that majority of the small borrowers or SMEs do not have access to formal finance and hence to that extent they may not benefit from policy actions that the RBI announces. 

In the manufacturing sector, large firms and MSMEs held up relatively well during the first wave. This led to lower than expected restructuring that was offered by the RBI. Many large firms and some better placed MSMEs took advantage of the loan moratorium and low interest rates to repair balance sheets – they deleveraged, and reduced the cost of borrowing, and some even piled up cash expecting sharply rising interest rates in the future.

In contrast, the second wave is likely to have much greater impact on service sectors SMEs (restaurant, retail and wholesale trade, hospitality, commercial real estate, small transport operators, etc) for reasons mentioned earlier. These constitute around 10% of total bank credit and consumer loans, which are about 30% of the total bank credit (of which about 5% is unsecured – the most vulnerable). Also NBFCs will be significantly impacted now, including the microfinance institutions (MFIs), which are already showing serious stress. 

It is also important to note in this context that banking sector employees have been impacted by the pandemic; estimates suggest that about 1.5 lakh employees have been infected. This has limited banks’ ability to do collections from retail customers; this issue is more acute with NBFCs and MFIs. 

On May 5, the RBI extended last year’s restructuring scheme by one more year and specifically included consumer and micro firms, but it does not have automatic loan moratorium and the borrowers have to apply. I think this makes it hard to implement; how many home loan borrowers or truckers will know or have the ability to apply for a restructuring?

RBI will have to announce some concrete relief measures for these segments. TLTRO will not help, there will have to be relaxation to Income recognition and Asset Classification (IRAC) norms, and maybe also a special package for NBFCs’ loan restructuring (NBFCs are about 9% of total bank credit).

IBT: What is your outlook for India’s recovery to its pre-pandemic size and level of growth? What are the steps that the government should take to revive economic activity and boost consumer sentiments?

Prof Rajeswari Sengupta: The second wave is more widespread, more severe, its geographic coverage is much greater and larger percentage of population has been affected. It is true that the lockdowns have been staggered (not the entire country at the same time) and less restrictive and hence the immediate impact will be smaller than say April-June, 2020. The contraction of GDP in the April-June 2021 quarter will be much less compared to one year ago. However the impact on economic activity will manifest over a longer period of time and the resultant economic slowdown may be more protracted.

The big difference of the second wave is heightened uncertainty given the delays in vaccination and the widespread fear given that the second wave affected the urban areas and because of the broken health care infrastructure, the impact has been devastating. It is not right to compare the current situation with the first lockdown because that was imposed by the government on the entire country. Whereas now, even when the regional lockdowns may not be stringent, people themselves may not step out and spend out of fear, and uncertainty; risk aversion is likely to be substantially greater than last time. This will delay the economic recovery longer than expected. 

The recovery itself may happen in stops and starts depending on the recurrence of a 3rd or 4th wave and/or mutations of the virus. If a large fraction of the population remains vulnerable to infections from the virus either because they have not been vaccinated or they have already not had the infection once then the chances of stronger mutations are higher. 

Due to the heightened uncertainty, households have gone into a cash conservation mode – cutting spending and wanting to defer loan repayments. Therefore, we are unlikely to witness the same degree of release of pent up demand now compared to say the October 2020-February 2021 period. We don’t know how this pandemic will play out and how long it will last. 

This kind of overall uncertainty about the pandemic, sluggishness in demand and the lacklustre response of the government to both is bad for private sector investment- an importan driver of growth and job creation. As long as the uncertainty remains, business confidence will stay muted and investment is unlikely to pick up pace. As and when the uncertainty abates, and vaccination gets ramped up investment will improve both from domestic and global players given that there is a vast amount of global capital that is floating around. However this may not happen until 2022 or even 2023. 

Lastly, initial conditions matter. Incomes and savings were worse at the start of the second wave compared to the first wave because of the financial pressure exerted by the first wave. Hence while last time was mostly a supply shock, this time it is largely a demand shock along with some supply disruptions due to the lockdowns. 

Damaged household balance sheets are much harder to repair than damaged business balance sheets. No amount of monetary actions helps, only fiscal stimulus does but there also as I said the government does not have any fiscal space to provide relief given that the debt/GDP ratio is already projected to reach 90%. 

The only source of growth that is visible right now is exports, given the resurgence of demand in the developed countries like the US and UK where the vaccination is happening at a much faster rate. India should take full advantage of this opportunity. 


Dr. Rajeswari Sengupta is an Assistant Professor of Economics at the Indira Gandhi Institute of Development Research (IGIDR) in Mumbai, India. In the past she has held research positions at the Institute for Financial Management and Research (IFMR) in Chennai, the Reserve Bank of India, and the International Monetary Fund (IMF) and the World Bank in Washington D.C. Views are her personal.
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