The pandemic led to a sharp economic slowdown worldwide. But even before COVID-19 struck, there was already signs of slowing growth in some regions. In India, corporate balance sheets were already showing strain, there was a spike in non-performing loans (NPA) among banks, non-bank financial institutions (NBFCs) were ailing and stark labour market weaknesses were visible.
In the first part of this conversation with Unravel, Priyanka Kishore, Head of India and South East Asia, Macro and Investor Services at Oxford Economics, speaks about the factors that signal a potentially impressive rebound for India in FY22 as the COVID-19 vaccine becomes available, and how India is coping with its post-COVID economic slump.
Unravel: According to your forecasts, India will grow 9.7% in FY22, after contracting 8.1% in FY21. What is driving this impressive growth rebound?
Priyanka Kishore: The favourable outlook for FY22 is supported by the strong rebound in private sector output from COVID lows, positive news on vaccines and expectation of a slow macro policy normalisation. In particular, India has been quite proactive in securing vaccines, which will be an important growth driver this year. Our initial estimates indicate the government may be able to vaccinate close to 10% of the population by the end of Q1 2021 and the vaccine would likely be more widely available by the middle of the year. This should allow a sustained relaxation of restrictions in states between Q1 to Q3 2021 without high risks of immediate flare ups of the virus, and spur ‘recreational or social spending’, among other things. Some service sector activity will also benefit from spillover effects from improvements on this front in other countries.
The deep economic damage caused by the coronavirus pandemic and lockdowns instituted to contain it make a prolonged growth impact inevitable.
However, it is important to note that positive base effects boost annual growth figures. Sequential growth is forecast to be only modestly higher in 2021 from 2020. I remain concerned about deteriorating legacy headwinds hampering the economic recovery, in the absence of a comprehensive fiscal response from the government to support private sector recovery.
Unravel: Can you elaborate more on the impact of legacy headwinds?
Ms Kishore: It’s likely that the headwinds already hampering India’s growth prior to 2020—such as stressed corporate balance sheets, elevated NPAs of banks, the fallout in NBFCs, and labour market weakness—will worsen in the aftermath of the crisis. The impact of this will be felt across the board in investment, employment and productivity.
For example, I expect two COVID-related developments to prolong the resolution of India’s balance sheet stresses and push out the expected investment payoffs from the corporate tax cuts announced in 2019.
The first is the suspension of the Insolvency and Bankruptcy code (IBC). Along with the Reserve Bank of India’s asset quality review, the IBC provided a framework for simultaneous resolution of balance-sheet stresses in the non-financial and financial sectors and a pathway for reviving credit growth. With this avenue for identifying distressed businesses closed for the time being, banks are likely to exercise higher discretion in extending credits to corporates.
Additionally, with lockdowns and the drawn-out pandemic likely to lead to more business failures, the bankruptcy process, which has already been faulted for being slow, will take even longer whenever the IBC is reinstated. This, in turn, will drag out deleveraging, delay recoveries for banks, risk a renewed upturn in the NPA cycle, and keep a lid on credit and economic growth. Loan moratoriums and subsidised credit made available in COVID-19 stimulus packages add to such risks.
Unravel: Moving on to the longer term, you forecast baseline growth in India from 2020-2025 will be 4.5% per annum, as compared to the pre-COVID estimate of 6.5%. Do you think India could have handled the economic implications of the pandemic better?
Ms Kishore: The deep economic damage caused by the coronavirus pandemic and lockdowns instituted to contain it make a prolonged growth impact inevitable. However, empirical evidence suggests that a strong near-term recovery, with growth returning to at least pre-pandemic trend in the year after the outbreak, leads to less medium-term scarring. In this context, the immediate policy response to COVID-19, especially fiscal, assumes even more significance. Unfortunately, India fares quite poorly in this regard.
It’s likely that the headwinds already hampering India’s growth prior to 2020—such as stressed corporate balance sheets, elevated NPAs of banks, the fallout in NBFCs, and labour market weakness—will worsen in the aftermath of the crisis.
Despite having one of the most stringent lockdowns globally in Q2, its direct fiscal response to COVID-19 so far amounts to just 2.5% of GDP, with the lion’s share of the $230 billion fiscal package earmarked for liquidity and financing support schemes. While we forecast the central government’s fiscal deficit will widen to 6.4% of GDP in FY21 from 4.7% in FY20, it is unlikely to deliver a meaningful boost to growth because it is not the result of a surge in spending. This isn’t to say fiscal assistance alone can plug India’s medium-term GDP shortfall, which is expected to be largest among major economies globally.
By 2025, we project GDP will still be 12% below the pre-virus baseline. However, an adequate and well-designed fiscal push, one that aims to boost potential growth rather than just prop up current spending, can limit the deterioration in pre-COVID problems that we have discussed.
* The second part of this interview focuses on India’s policy choices and long-term economic prospects.