IN TROUBLED WATERS
The slowdown has become a most debilitating recession. It will take some urgent and daring interventions from the government to pull the economy out of this deep hole
The economy is in recession and possibly in worse shape than it has ever been in the history of independent India. It is in urgent need of some daring and decisive government intervention
-4.5 PER CENT The IMF’s estimate of how much the economy will shrink in FY 2020-21
MMahadev Kadam, 48, wears a stony look as he sits in his small textile shop in Panvel in Navi Mumbai, watching the pouring rain on an August morning as he prepares for yet another day of scanty footfall. He says there was no business from end-March to end-June because of the lockdowns ordered by the central government and local administrations, and though business seemed to pick up in the initial days after his shop reopened in end-June, that soon fizzled out.
Huddled in a chair, behind a rope tied across his shop’s entrance to stop customers from going in—as instructed by local authorities—he says he can’t remember a worse time in his three decades in business. “Forget replenishing stock,” he says, “I haven’t even sold out the old stock I bought in the new year. Even the Ganesh festival (which began on August 22) hasn’t helped.” He has bills to pay—Rs 8,000 monthly rental for his shop—and with the three-month moratorium he availed on a personal loan ending in August, he faces an uncertain future.
The Covid-19 pandemic, the protracted lockdowns and weak demand have devastated millions of businesses across India, both large and small, pushing several like Kadam’s into bankruptcy. The service sector remains the worst hit, especially for firms in retail, hospitality and travel. Several MSMEs (micro, small and medium enterprises) are struggling to survive or are working at a fraction of capacity. Some have been forced to change their product portfolio altogether, switching from engineering products or chemical goods to making hand sanitisers, soaps, personal protection equipment and the highly in-demand masks—but earning much less than before. Even large businesses are operating their plants at low capacity, managing with fewer staff, and laying off the rest. The knock-on effects are visible as well. The Centre for Monitoring Indian Economy (CMIE) says that 18.9 million salaried workers have lost their jobs since the lockdown began, with about five million jobs lost in July alone. This, in turn, has hurt demand, and poor demand has crippled investment. Businesses are borrowing less from banks as they put investments on hold. The banking sector—burdened with Rs 7.27 lakh crore worth of bad loans, as per government estimates—is likely to see even more NPAs in the coming months as individuals and companies default on loans due to business failures.
THE BITTER TRUTH
Across the board, agencies are forecasting dismal GDP growth numbers. There seems to be a general consensus that the Indian economy shrank anywhere between 13 per cent and 23 per cent in the April-June quarter of the current fiscal. Worse, experts are forecasting negative growth for the entire fiscal year, with their projections of the expected contraction ranging from 3.2 per cent to 9.5 per cent. The International Monetary Fund, for instance, has predicted that the Indian economy will shrink by 4.5 per cent this fiscal year.
The bitter truth is that India is going through its first recession since 1979-80, when the economy shrank 5.8 per cent (at the time, it was heavily dependent on agriculture and had experienced two years of bad monsoon). The National Bureau of Economic Research, a US-based think-tank, defines a recession as ‘a significant decline in economic activity across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales’. On August 6, Shaktikanta Das, governor of the Reserve Bank of India (RBI) said India’s GDP growth for the first half of the year “is expected to remain in the contraction zone”, with real GDP growth expected to be negative for fiscal 2021. “Two quarters of negative growth amounts to recession, and there certainly has been negative growth in the June and September quarters,” says former finance secretary Subhash Chandra Garg. He estimates that India’s economic output dropped 25 per cent in the quarter ending June. “It’s a lot but not unprecedented,” he says—the US economy lost about 30
“Investment has to go up [for economic revival]. If that does not happen, from 4.2 per cent growth, we’ll go down this year to -7 or -8 per cent” KAUSHIK BASU Former chief economist, World Bank
per cent of its output, and the UK’s, about 26 per cent, in the same period. In either case, in India, the four key engines of growth—domestic consumption, private investment, government expenditure and exports—are all faltering.
THE COST OF COVID
The business closures, job losses and salary cuts resulting from the Covid lockdowns have dealt a body blow to consumption—lower incomes naturally translate to less spending. In its annual report released on August 25, the RBI noted that ‘the upticks [in consumption] that became
visible in May and June after the lockdown was eased appear to have lost strength in July and August, mainly due to the reimposition or stricter imposition of lockdowns’. It highlighted that the shock to consumption was severe, suggesting that ‘the contraction in economic activity would likely be prolonged into the second quarter’, also noting that consumer confidence fell to an all-time low in July, with a majority of respondents to a recent survey reporting pessimism over the general economic situation, employment, inflation and income. This is visible in consumption data—there has been an all-round dip in demand for goods and services. For instance, the real estate sector is saddled with huge inventories, with 455,351 unsold units in eight major cities at the end of March this year, worth an estimated Rs 3.7 lakh crore. Similarly, passenger vehicle sales and the supply of consumer durables in urban areas in the first quarter of fiscal 2020-21 have dropped to a fifth and a third, respectively, of their levels a year ago.
With consumption plunging, private investment has fallen too—without a market for their products, companies have little incentive to spend on new projects. According to CMIE, year-on-year growth in new investment projects was a meagre 1.85 per cent in 2019-20. Just five years ago, that figure was 103 per cent. The slowdown has also resulted in firms tightening their purse strings and cutting back on borrowing. Fund raising by India Inc. fell 78 per cent in the first quarter of calendar year 2020, with firms choosing to manage expenses with existing cash flows rather than by raising funds. Several private equity funds are sitting on considerable stocks of ‘dry powder’ (funds already raised), unable to find investment avenues. On the other side of the equation, banks—especially in the public sector—remain wary of lending, having suffered significant losses in the recent past. According to a Crisil estimate, bank credit growth will nosedive to a multidecade low of 0.1 per cent this fiscal year.
The behaviour of the stock markets, however, is a study in contrast. In the April-June quarter, markets rose nearly 20 per cent—the highest quarterly growth in almost 11 years—recovering losses from the initial days of the pandemic. On August 26, the BSE Sensex gained 230 points to close at 39,073.92. India has outperformed other emerging markets in terms of inflows from foreign portfolio investors—inflows in August 2020 so far stand at $6 billion. Experts say that after being perturbed by the initial lockdown shock, the stock market is returning to India’s long-term growth story, and has the potential to cross the 42,000 level it had touched in the days before the lockdown.
Many had expected the decline in private investment to be offset by government expenditure, especially on the infrastructure front, hoping that this would provide jobs and create more demand for commodities such as cement and steel. In December last year, finance minister Nirmala Sitharaman had announced Rs 102 lakh crore of infrastructure projects, to be implemented over the next five years. These projects spanned the power, railways, urban irrigation, mobility, education and health sectors. In April this year, the government had also targeted the construction of Rs 15 lakh crore worth of roads over the next two years. Despite these announcements, little has materialised. For instance, government data shows that spending on road construction dropped from Rs 1.37 lakh crore in 2018-19 to Rs 85,275 crore in 2019-20 (till November 2019), with road building slowing from 10,855 kilometres a year in 2018-19 to 6,940 kilometres in 2019-20 (up to December 2019). State governments, which were expected to spend at least 40 per cent of the Rs 111 lakh crore National Infrastructure Pipeline till 2025, also drastically reduced capital spending in 2019-20. “States have a two-thirds share in public investment, but they are not in a position to spend much in any area other than healthcare at present,” says Madan Sabnavis, chief economist with Care Ratings.
Even exports appear depressed, contracting for the fifth straight month in July, declining by 10.21 per cent
year-on-year due to a drop in shipments of petroleum, gems and jewellery, leather and leather products and electronic goods, among others. According to data from the ministry of industry and commerce, merchandise exports stood at Rs 1.77 lakh crore in July 2020, as compared to Rs 1.81 lakh crore in July 2019, a negative growth of 2.14 per cent. For the April-July period, India’s overall exports are estimated to have been about $141.82 billion, falling 21.99 per cent over the same period last year. With Covid-19 forcing countries to raise transport barriers to prevent a spread of the virus, the impact on global trade was inevitable. However, Ajay Sahai, director general of the Federation of Indian Export Organisations, says exports are recovering—the lower numbers reflect the fact that the items of export have been mostly lower-priced raw materials. “This fiscal, we started with a 65 per cent decline in apparel exports, which recovered to 12 per cent in June,” he says. For pharma and technical textiles, the market is very good and India is capturing greater share. “China has taken a huge dent as far as edible products are concerned, to India’s advantage,” he adds. The problem with exports of apparel, footwear, gems and jewellery and handicrafts, he explains, is that orders are coming in for the short term. “Normally, by this time, we would be getting orders for FebruaryMarch next year, but we are only getting orders for the pre-Christmas period. Buyers are not taking long-term calls since they are unsure of the market.”
In the midst of all this, India also had to contend with incursions by China across the Line of Actual Control, leading to several weeks of tension between the two countries and the deaths of army personnel on
“Atmanirbhar Bharat focused on MSMEs, [which] are big job creators. Giving them credit minimised the [economic] impact [of Covid] significantly” K. SUBRAMANIAN Chief Economic Advisor, Department of Economic Affairs, Ministry of Finance
both sides. The tensions also led to a public outcry to boycott Chinese goods, culminating in India banning 59 popular Chinese apps and putting restrictions on the flow of capital from that country. Also, the government’s Atmanirbhar Bharat campaign focuses on building domestic capabilities in a host of sectors, which is obliquely intended to keep out Chinese companies and products.
With the key pillars of the economy now tottering, the economic outlook for the remaining quarters of this fiscal year remains cloudy. The jobs market will continue to feel the squeeze as companies tighten their belts to tide over the crisis. The informal sector and MSMEs will be among the worst hit. Meanwhile, high inflation, driven by spiking food and fuel prices, is hurting middle class budgets and keeping policy makers on tenterhooks.
WHAT COMES NEXT
The damage caused by the pandemic to the four engines of economic growth as a result of business closures, job losses and salary cuts is likely to lead to more bad news on those very fronts.
Consider job losses. Some businesses have been hit especially hard by the global and domestic lockdowns, notably firms in the service sector working in travel, aviation and hospitality. IndiGo, India’s largest air carrier by market share, has already laid off 10 per cent of its staff, or about 2,300 people. This trend is likely to continue as long as the pandemic and the resultant lockdowns remain a factor. A report by Crisil says India’s air passenger traffic is likely to contract massively this fiscal year—domestic travel by 40-45 per cent, and international travel by 60-65 per cent. Similarly, the hospitality sector is estimated to have lost about Rs 1.25 lakh crore in revenue in 2019-20, according to Care Ratings. These numbers foretell more job losses, worsening the impact on economic growth. Manufacturing is another sector caught in this vicious cycle. MSMEs, which employ about 120 million Indians and account for about 45 per cent of India’s exports, are especially vulnerable. The automotive sector is in a similarly precarious position. Employing about 44 million and contributing about 9.4 per cent to India’s GDP, this sector saw total domestic sales halve in June this year, putting salaried and contract jobs at risk.
“What is happening in salaried jobs is very worrying,” says Naushad Forbes, co-chairman of Forbes Marshall and former president of the Confederation of Indian Industry. He says firms across industries need government support to ride out the storm, perhaps in the form of loan guarantees like those extended to the MSME sector. It is enormously important to prevent job losses, because those will trigger further contraction in spending, further damaging domestic demand and causing business closures, leading to more job losses and triggering yet another turn of the vicious spiral.
The stimulus announced by the government in May has clearly not had the desired effect. The announcement of the Rs 20 lakh crore package—broadly focused on easing the availability and terms of credit for MSMEs and income support for farmers and those at the bottom of the economic pyramid—gave some hope, but now appears to have been grossly inadequate in addressing the pain. Though there were a host of interventions to improve business prospects for small firms—such as pushing public sector undertakings (PSUs) to quickly pay their outstanding dues to such firms, asking banks to put a moratorium on loan repayments for six months and restructuring regulations relating to MSMEs to incentivise growth—months later, most small businesses are still battling for survival. R.K. Bharadwaj, national vice president of Laghu Udyog Bharati, says the primary problem is that consumption has crashed. “There is an uncertainty in demand,” he says. “That is hurting us the most.” Though other business problems have eased—such as the loss of labour because migrant workers were unable to travel to and from their home states to their places of employment due to the lockdown—this loss of demand means that businesses simply cannot earn as they used to. Loan moratoriums, the receipt of outstanding dues from PSUs and easily available credit cannot compensate for such a fundamental problem.
For example, Vinod Thapar, chairman of Knitwear Club in Ludhiana, says the continuing closure of retail shops has hit demand and forced factories to run at 30-35 per cent capacity. (Ludhiana is a hub for high-value garments manufacturing.) Meanwhile, MSMEs supplying to PSUs say that while these enterprises have largely started releasing pending payments, new orders are absent. Even positive developments in some sectors come with caveats. For instance, exporters say demand for textiles, automobile components, sports goods and hand tools has picked up, but is still much lower than pre-Covid levels.
The only silver lining seems to be the rural economy. “The rural economy, which supports 60-70 per cent of India’s population and accounts for 46 per cent of the GDP, is surging,” says Jayant Sinha, chairman of the standing committee on finance and a BJP MP in the Lok Sabha. “Almost 100 million farmers have received Rs 40,000 crore as income support through the PM Kisan Samman Nidhi.” There are some reasons for hope here—tractor sales picked up by 38.5 per cent in July, spurred by the robust pace of kharif sowing, while the contraction in motorcycle sales eased in the same month, from 35.2 per cent in June to 4.9 per cent in July. There has also been an uptick in the consumer nondurables market. However, there are major caveats here as well. Experts point out that rural demand contributes only 15 per cent to India’s GDP—the sector is simply not
large enough to revive the overall economy by itself. Also, as the RBI notes, ‘A fuller recovery in rural demand is being held back by muted wage growth, which is still hostage to the migrant crisis and associated employment losses.’
Inflation is another problem. As measured by the consumer price index (CPI, a weighted average of prices of a basket of consumer goods and services), inflation came in at 6.9 per cent in July, breaching the upper band of the RBI’s inflation target for the fourth consecutive month. This will have consequences for consumption—with job losses and salary cuts, consumers have already seen their budgets shrink. A hike in prices will only damage demand further. What is unique about this situation is that inflation is not being driven by too much money chasing too few goods; instead, both demand and supply have crashed, leading to higher prices of goods. One immediate consequence being widely discussed is a halt in the RBI’s rate-cutting spree—on August 6, the central bank’s Monetary Policy Committee left the repo rate (the rate at which commercial banks borrow from the RBI) unchanged at 4 per cent, and the reverse repo rate at 3.35 per cent. While this may ease the inflationary pressure somewhat, it also means that loans will not get any cheaper, moderating the potential increase in borrowing and investment.
THE ANTIDOTE
The pandemic and its consequences— for income, jobs, demand and investment—sit at the very heart of the economy’s present ills, and recovery depends critically on how soon a vaccine can be developed, brought to market and made universally available.
In the short term, many solutions have been proposed. A major clamour has been for a second stimulus package. For instance, the MSME sector has been lobbying hard for a Government bailout package to pay staff salaries. However, the government appears to be taking a wait-and-watch approach to assess the extent of damage to the economy before taking another major financial step.
Many experts that india today spoke to say the government should loosen its purse strings. They argue that the central fiscal deficit target should be raised from its current three per cent of GDP to four per cent, and that state governments’ debt-to-GDP target should be raised from the current 20 per cent to 30 per cent. This, they argue, would increase the government’s ability to spend, directly boosting one of the economy’s four major engines (see Can India Recover?). They argue that these funds should be spent on providing income support to poor households and financial support to vulnerable businesses. Another aspect is addressing the working capital crunch—if larger companies have access to low-cost lending, they would be better poised to make payments to their smaller suppliers.
Others pitch for demand-side interventions—direct cash transfers and tax cuts to leave more money with consumers so that domestic consumption increases. They recommend that the government allocate more funds for income transfers, to schemes like MNREGA, speed up the transfer of revenues owed by the Centre to state governments and increase government spending on public infrastructure. Other proposals include the extension of the free
“India needs to go beyond protectionism— it should develop trade deals with Southeast Asia, the European Union and the United States” NAUSHAD FORBES Co-chairman, Forbes Marshall
foodgrain distribution scheme. They also recommend medium- and long-term structural interventions like privatising power distribution companies, encouraging FDI in railways by clearing land acquisition bottlenecks, easing procurement rules, and so on.
Naushad Forbes is one such proponent, arguing that structural reforms are the need of the hour. These include reforms to the financial sector to reduce high interest rates—Indian manufacturers currently pay 12-14 per cent interest on borrowings, the highest among emerging market economies, with even blue-chip businesses paying interest at 7-10 per cent. The high cost of capital makes it impossible for Indian exporters to compete with firms in countries where the cost of capital is less than half that figure.
Others suggest a continued focus on MSMEs and salaried employees. One proposal is to introduce an urban variant of MNREGA, under which workers in small firms in the unorganised sector get Rs 200 a day from the government. The thinking goes that this would have three benefits—jobs would be saved, employers would see reduced wage bills, and the registrations for such a scheme would improve administrative databases on the unorganised sector, improving the formalisation of the economy. “We need to spend an additional Rs 3-5 lakh crore to provide employment support to MSMEs and transfer more money to states. We also need to spend aggressively on infrastructure,” says a policymaker, requesting not to be named.
The government’s focus so far has been on rescuing those in most danger—MSMEs and those at the bottom of the economic pyramid. However, there are others that also need urgent assistance. For example, when it comes to job losses, there are two distinct groups that need help—those who have already lost their jobs, and those in danger of losing their jobs. Other countries have followed unique models to address these issues—Canada, for instance, is offering to subsidise the wage bill of companies that have lost more than 30 per cent of their revenue. In India, this would pose significant risks, for two reasons—the absence of credible data, and the ever-present threat of fraud.
In the medium to long term, an area that needs to be addressed is foreign investment. So far, global investors have proved hesitant to invest in India, partly because of the complexity of laws. Though the country has made progress in attracting investment in electronics like smartphones, these sectors are too small to really move the GDP needle. A similar push is needed for larger industries.
Many also argue that the RBI and the finance ministry should look at ways to pump in money to create demand-side inflation. This includes direct interventions like printing more currency to create more cash in hand. Some economists argue that demand-side inflation is not a bad thing for a depressed or recessionary economy. Others say that high inflation benefits only the earner from that inflation. “When food prices are higher, sellers will benefit. It can be an incentive for manufacturing,” says Sabnavis. In its annual report, the RBI highlights the clear need for more financing options, saying that alternatives to bank finance, such as a corporate bonds market, must be found. It also highlights the need for specialised NBFCs classified as infrastructure finance companies to make longer term loans available for infrastructure development.
Some argue that since the current recession is not caused by business cycles, reforms should wait until the economy has fully reopened and the full extent of damage is in view. “If we implement policies that are more suited to business cycle recessions now, we might later find that we were barking up the wrong tree,” cautions an economist with a global bank.
The Indian economy is going through one of its toughest phases ever. It was already in the midst of a slowdown when Covid-19 pushed it over the edge. The extreme crisis demands daring solutions. The government must appreciate the pain various segments of the population are going through. It will need to generate reliable data, carry out targeted policy interventions and simplify procedures to rebuild a post-Covid economy. The extreme disruption caused by the pandemic is also an opportunity for the government to reset the Indian economy, but to turn adversity into opportunity, its policymakers must act urgently and decisively.