India’s economy struggles to emerge from the shadows of the pandemic

India’s GDP grew by 20% in the April to June quarter this year, but it was on the back of a 24% contraction a year ago, underscoring the challenge India has on its hands as it looks to recover following a devastating second wave of the pandemic.

To take stock of where the Indian economy stands presently, we speak with Ritesh Kumar Singh, chief economist at Indonomics Consulting and a former assistant director of the Finance Commission of India. Mr Singh talks about the key challenges confronting the Indian economy, employment and medium-term prospects.

Unravel: India’s GDP grew by 20.1% in the April-June quarter, compared to a year earlier, when the Indian economy shrank by 24%. How do you assess this performance?

Ritesh Kumar Singh: Despite the official exuberance over 20.1% growth in India’s April-June quarter, things are not as rosy as the Indian government likes to claim. It’s a big relief, yes, but India should not be celebrating yet. Despite a 20.1% jump, GDP in Q1 FY2021/22 is 9.2% lower than what it was two years back, in Q1 FY2019/20. That’s not the only problem though. Except for agriculture and allied sectors, and public utilities (electricity, gas and water supply), the gross value added of every other major sector of the economy was lower in Q1 FY2021-22 than two years earlier.

Manufacturing has almost recovered to pre-pandemic days, except maybe automobile and consumer electronics, due to chip shortages. However, the two most labour-intensive sectors—construction and trade, hotels, transport and communication—have not recovered fully. These two sectors employ a lot of workers (mostly contractual) who have either witnessed salary cuts or job losses. This is bound to adversely affect consumer demand. Weak consumer demand, along with under-utilisation of existing productive capacities, will keep private investment sluggish as companies will push back their capital expenditure plans. That will slow economic recovery. 

Unravel: What about exports?

Mr Singh: The only thing going well for the Indian economy at present is the external sector. Helped by a sharp global economic recovery, Indian exports are booming despite a surge in freight charges. In the first five months of the current fiscal year (April-August), India’s merchandise exports increased to $163.67 billion from $98.05 billion in April-August 2020 and $133.14 billion in April-August 2019.

Meanwhile, India’s services exports have remained steady as they have been largely unaffected by the pandemic. 

In addition to robust exports, mostly foreign venture capital and private equity firms brought in over $20 billion in the first seven months of 2021 and provided a much-needed stimulus to the Indian economy.

Unravel: What are the Indian economy’s medium-term prospects? 

Mr Singh: The prospects are brighter, in my view. Faster economic recovery in the EU and US will support Indian exports amid increasing attempts in the western world to cut their China exposure in the supply chain. That will support export-focused sectors such as labour-intensive apparels, home textiles, leather goods and jewellery, in addition to engineering goods, pharmaceuticals and IT services.

With President Xi’s crackdown on Chinese tech companies, interest from venture capital and private equity in Indian tech companies should continue to support the Indian startup ecosystem. I suppose, with domestic savings (mostly household savings) on the decline, foreign capital could play a bigger role, especially after the reversal of the retrospective tax rules – one of the major policy risks for foreign investors.

I do hope that the Indian government will show flexibility on investment protection treaties, one of the major hurdles in the way of an India-EU Bilateral Trade and Investment Agreement (BTIA). The conclusion of the India-EU trade pact will further improve export market access for Indian goods and services. Similarly, online retail platforms are expected to help thousands of small sellers overcome the limitation of small-sized local markets by turning many of them into pan-India and/or global sellers. That will further add to India’s exports.

Unravel: In your view, is the Indian economy faced with cyclical or structural challenges?

Mr Singh: In my opinion, it’s a combination of both, cyclical (temporary mismatch) and structural (long-term or permanent) challenges, although it is the latter that has been hampering India’s growth prospects as we speak. Under the first category comes the recent surge in freight charges troubling exports and commodity price inflation that has raised input costs for most businesses. Under structural challenges come the increasing capital intensity (prompted by lowering of interest rates) in a labour-abundant country. That will only worsen the problem of unemployment. Moreover, low (negative if adjusted for inflation) interest rates also encourage the sub-optimal use of capital. The result is an increase in the incremental capital output ratio – which means India will need increasingly more capital to maintain the same level of GDP growth. Similarly, the slashing of corporate taxes—which essentially excludes SMEs, sole proprietorship and partnership firms as well as LLPs—will aid the concentration of economic power with a few large corporations and increase inequality of income and wealth that will cap consumer demand and in turn GDP growth.  

Unravel: What are some areas of the economy that are showing signs of recovery? 

Mr Singh: I think most sectors and sub-sectors of the Indian economy are showing some signs of recovery. However, the degree of recovery differs across different sectors. Thus, manufacturing is doing better than hospitality and tourism. Similarly, large firms in most sectors are doing better than smaller ones, and the formal sector of the economy is doing better than the informal sector.  

Unravel: What sectors continue to be in trouble, in your view? 

Mr Singh: I think, despite media hype about increased sales of bikes and cars and premium homes, both the auto and real estate sectors will continue to struggle for long. In the automobile sector, especially the producers and sellers of conventional ICE vehicles will struggle due to high goods and services tax (GST) and cess of up to 50%, unreasonably high fuel prices due to extracting taxes, and increasing cost of motor insurance that makes owning personal vehicles a questionable idea for many. Similarly, rising cement, steel and building materials costs in general will make homes pricier and adversely affect demand, despite a brief spurt in demand in selected pockets that has been prompted by a reduction in stamp duties and registration charges.  

Unravel: What are some of the key challenges to economic recovery? 

Mr Singh: The increased cost of inputs for most industries, high fuel taxes that have raised shipping and logistics costs are a key challenge. As is the slower recovery of household demand for discretionary goods and services due to a fall in income or job losses or pessimism about future income. Finally, a key challenge is the precarious condition of the country’s informal sector, with issues starting after demonetisation and then forced formalisation attempts through a badly designed and poorly implemented GST that has increased compliance costs. All of this will come in the way of a faster economic recovery.

Unravel: Despite the economic recovery, India’s unemployment rate rose from 6.95% in July to 8.32% in August. Do you expect to see a recovery in employment anytime soon? 

Mr Singh: Some improvement in the job market will no doubt happen, especially in net exporting sectors such as IT, pharmaceuticals and textiles; but as I’ve mentioned, India’s unemployment problem is largely structural – caused by increasing capital intensity in a labour-abundant economy.

Similarly, smaller firms have effectively been neglected by the Modi government. The slashing of profit taxes and the implementation of production linked incentive schemes (PLI) exclude smaller business entities. On the other hand, other policy measures such as demonetisation and attempts to forcefully formalise the informal sector through GST reform actually punishes smaller companies.

These smaller business entities tend to have higher labour intensity, and their poorer economic prospects will worsen the unemployment problem going forward.    

Unravel: How do you assess the government’s handling of the economy from a COVID context? 

Mr Singh: Despite some really bold reforms in the Modi administration’s first term, such as the Insolvency and Bankruptcy Code, the Real Estate Regulatory Authority Act and the GST, their poor design and implementation limited their positive impact on the economy. Post-COVID, due to stressed finances, and a pre-mature slashing of corporate taxes in September 2019, the government is not really in a position to help. For instance, it’s no secret that high fuel taxes are troubling all sectors of the economy through increased logistics and transportation costs, yet the government cannot reduce them. Similarly, a well-thought vaccination programme would have sped up the economic recovery, but a poorly managed one has ruined India’s prospects, despite us having an early mover advantage.