India has witnessed a significant decline in the gross domestic product (GDP) during a tense deadlock with a wealthier and nuclear-armed neighbour. Finance Minister Nirmala Sitharaman has assured the public that the budget this year will be very different, beginning with its paperless nature.
Five key challenges need to be addressed to tackle India’s economic conditions. Most of these have been existing before the COVID-19 pandemic hit India but now require immediate attention in wake of the lockdown. Economic destruction fled through the country. It is important to note that all five challenges intersect and need to be pursued together to ensure a recovery that is sustainable for the future.
1st challenge: Promoting domestic demand
A notable theme for fund-managers, India’s ‘consumption story’ began to fall even before the pandemic. The lockdown caused a slump in spending. The National Sample Survey (NSS) report from 2017-2018 on consumption spending defines that real rural consumption expenditure fell between 2011-2012 and 2017-2018. In contrast, it increased in urban India but the overall consumption numbers had a fall.
India’s national accounts statistics which utilizes numbers to generate consumption spending is inclined to show a brighter picture. Although, those numbers represent a pre-pandemic slowdown in consumption before the subsequent disintegration in fiscal 2021.
It is predicted that the coming months will see a rise in consumer spending with the reopening economy, rising mobility and improving immunity. Some of the enforced savings of the better-off will find its way into new spending now. Meanwhile, after the initial ‘sugar-rush’ of pent-up spending which can be seen through the Q3 reports of companies, domestic demand may remain weak, wrote J.P. Morgan economists Sajjid Chinoy and Toshi Jain in a report dated 7th January 2021.
Among urban Indians, the propensity to spend on big-ticket items appears fairly low, a recent online survey of nearly 10,000 respondents spread across 203 cities and towns show.
Consumer confidence has been dented sharply by the pandemic and it could be a while before that reverses fully. Moreover, the loss of jobs and incomes at the bottom of the pyramid could act as a drag on domestic demand in the medium term unless the labour market heals faster, as Chinoy and Jain point out in their report.
2nd Challenge: Generating decent jobs
The sustainability of the consumption comeback in the imminent years will ultimately depend on India’s ability to generate decent and well-paying jobs. Over the past few years, the ranks of the salaried class had expanded, even if at a slow pace. The pandemic has however led to a sharp fall in the ranks of the salaried class according to data from CMIE’s household surveys. 21% of the workforce surveyed were in salaried jobs in fiscal 2020. This figure was reduced to 17% in the September-ended quarter last year and only increased marginally to 18% in the December-ended quarter.
An issue is that salaried people in India may lack even a formal letter of appointment. However, such ‘regular’ jobs allow for greater consumption-smoothing than the irregular and infrequent engagements that heads India’s informal economy. The loss of millions of jobs during the pandemic has impacted consumption and raised inequality at the same time.
3rd Challenge: Reviving animal spirits
This insists that job-creation must be at a scale which will require the country’s entrepreneurs to step up investments. India’s investment cycle has been dying for several years but the past year has been absolutely bleached.
As a share of India’s GDP, new investments are expected to fall to 24% this fiscal which is a 20-year low. The investment rate had peaked at 36% of GDP in 2007-08 and has observed a steady decline since then.
As hoards of bad loans piled up in the years after the 2008 financial crisis, both firms and lenders turned risk-averse in taking up new projects. Risk-aversion remains high even as funding for new projects has waned. If lack of clearances was the major hurdle facing new projects around a decade ago, lack of financing has appeared as the large bottleneck now.
4th Challenge: Terminating the credit drought
Since a few years, banks have had a bit of success in reducing the share of toxic assets on their books but the pandemic can undo those gains. Stress test results by the central bank (RBI) in its latest financial stability report indicate that the share of bad loans could rise to 14% by September 2021, nearly double what it was in September 2020.
At a time when credit growth has been anaemic, this would further restrict lending.
Lending can increase movement only if banks can find additional capital cushions to offset the damage of their assets. For state-owned banks, this means either infusion of equity through stake sales or abundant budgetary provisions for recapitalization.
It is worth noting that Indian banks are relatively under-capitalized compared to contemporaries in other large economies. Till they remain parched of capital, they are unlikely to finance the next investment cycle.
5th Challenge: Increasing spending without inciting inflation
The three key engines of the economy which are consumption, investments, and exports – are breaking down today, the primary power in town is the government, which will need to steer the economy till the other engines pick up the pace. This implies additional borrowing which would overburden the public debt-GDP ratio. Rating agencies hope that the debt-GDP ratio will surge in fiscal 2021 but they would expect a fiscal consolidation path that stabilizes public debt at current levels and then trends lower, wrote Nomura economists Sonal Varma and Aurodeep Nandi in a report dated 19 January.
If higher spending is largely administered to fund CAPEX, which in turn will raise growth and enhance future revenue streams, it could bring down the debt-GDP ratio in a few years ahead.
Although, if such spending is directed largely towards revenue expenditure, it could lead to inflationary pressures without doing much for growth. At a time when commodity prices are rising globally, this would entangle the task for India’s monetary policymakers and risk driving the economy towards stagflation.
Nirmala Sitharaman must come to terms with these challenges in the upcoming budget.