After the storm

Now that the steep decline in economic activity is behind us, it is time to assess what parts of the economy have the worst scars

Even as the number of cases and daily deaths are at unacceptably high levels, there are several reasons why the opening up of the economy is unlikely to be reversed. The case-fatality rate has been falling since June, and is now incrementally at 1.3 per cent. Epidemiologists offer several hypotheses for this: Improving medical protocols for treating patients (for both doctors and other medical staff ); availability of proven medication for severe cases; a possible weakening of the virus’ potency (as seen earlier in diseases like chikungunya and swine-flu); and possibly the viral load causing the infection in less-densely populated areas (unlike denser urban areas) being small enough to cause only a mild infection.

Further, the Indian Council of Medical Research’s (ICMR) national surveys of antibody prevalence have shown infection-to-test-ratios of 25 to 82, implying that infection fatality rates are in the one-in-two-thousands to onein-a-thousand range. As this evidence accumulates, regulators are continuing to ease restrictions, and as people experience a lower fatality rate, they are starting to lose some of the fear of the virus. As the 24 per cent decline in gross domestic product (GDP) in the first quarter was mostly due to activity restrictions, this has meant a rapid revival in economic activity, and not surprisingly, several indicators are now reaching pre-crisis levels, like car sales, goods and services tax (GST) e-way bills, power demand and now even demand for petrol and diesel. Sellers of durable goods are now more concerned about supply than demand. These yearon-year comparisons are being helped by the second half of the last financial year being weak, but the sequential pick-up in activity as well as sentiment is unquestionable.

Now that the months of steep decline in yearon-year measures are over, and the bulk of the pain of the expected 8 to 10 per cent decline in full year GDP has already been felt, it makes sense to look at the economic damage caused in the last six months. That is, how this loss is distributed among various constituents of the economy: The government, wage earners (i.e. individuals), formal firms and informal ones. This exercise could also help decide where the government can intervene to minimise the longterm damage and to revive the economy, and likewise, for investors to anticipate which categories could bounce back first, and which could take the longest to recover.

A deep dive into India’s national accounts with some reasonable assumptions shows that of the about ~20 trillion of GDP loss in terms of disposable income, the government(s) bear about half of it, and wage earners and firms a quarter each.

As central and state governments largely maintain their expenditures, and lose both direct and indirect taxes, their borrowing requirements have gone up. This is socialisation of economic loss over current and future taxpayers, and as close as possible to “water under the bridge” — that is, minimal lasting damage. However, the uncertainty in the split of the loss between the central and state governments creates an overhang on capital expenditure by state governments. This is a complex problem much larger than that of just GST compensation, and is likely to take time to resolve.

The losses for wage earners (lost jobs, salary cuts, lower returns on financial savings, lower rents) in aggregate are also “water under the bridge” as consumption during this period was weak too. However, once we get into the details, it emerges that the income and the consumption impact is felt by different individuals. Services are the worst impacted when one restricts activities; these are by definition provided by low-wage earners to high-wage earners. People are just buying the time of others (like drivers, waiters, teachers, shopkeepers). There are only a few highly skilled jobs (like in medicine or law) where this does not apply. Thus, activity restrictions mostly impact the consumption of high-income earners and incomes of the low-income workers. So, while all wage-earning segments would have been hurt during the peak of the pandemic, the highincome households are likely to emerge from the pandemic with more financial savings, and conversely, the low-income households with fewer assets or higher debt.

The recovery in jobs also may not be automatic, given that firms that generate employment have lost too. In our estimate, formal firms bear 10 per cent of the total ~20 trillion loss, and informal (unregistered, that is) firms account for 15 per cent. This loss means lower risk capital available for future investments. As firms generally borrow an amount equivalent to the risk capital, the impact on investments in the economy doubles to nearly 5 per cent of GDP. This threatens to bring down potential growth rate for the next year or a few.

Formal firms, being larger in size, have been better off, also benefiting from lower financing costs. Informal firms, lacking access to formal financing, are more reliant on their savings for future investments. Their potential growth rates therefore are likely to be lower than that of formal firms, and in case some shut down, a regression of workers from services or manufacturing back to agriculture, as some recent data suggests (though hopefully only temporarily), would take longer to reverse.

Weak household and firm balance sheets mean weaker aggregate consumption and investment even after the restrictions are lifted; the rebound caused by pent-up demand may fade in a few months. Combined with the pressure on state government finances, as well as the damage to sentiment, investment revival may take the longest. Discretionary demand from low-income households (which often overlap with informal firms) could also remain sluggish, even as the upper-income segments start spending their excess savings accumulated during the lockdowns.

Thus, the segments that may need help the most (and we believe the socialisation of whose losses would be in the collective interest of all) are the urban poor, informal sector workers and smaller informal enterprises. In our view, the challenge for policymakers will be in devising schemes that target these segments, as suitable plumbing does not exist yet to direct funds there without leakage or misdirection.

It is worth remembering that the challenge is not fiscal space. As explained in this column in August (“Handling the Dollar Deluge”, August 5), a large and persistent balance of payments surplus can create distortions, and a boost to domestic demand through a fiscal stimulus would be the best way forward. The RBI’S currency market interventions to prevent the rupee from appreciating create surplus liquidity, which can be routed to funding government borrowing through policy measures.