Nine months into the pandemic, where is the economy headed? In this interaction with a nationwide audience, Sajid Z Chinoy, Chief India Economist at JP Morgan and Part-time Member in PM’s Economic Advisory Council, discusses with P Vaidyanathan Iyer the challenges and suggests ways to meet them. Edited excerpts:
On the world economy nine months into the pandemic
The question we should be asking ourselves is, what is the permanent damage that Covid is going to do to economies around the world? Two years from now, will there be permanent damage to output? And this is where the IMF analysis is important. There are actually estimates that there will be $11 trillion of lost output in 2020-2021, but over the next 5 years, there will $28 trillion of lost output. In particular, the Fund estimates that for developed markets, GDP will be 3.5% below what they would have been pre-pandemic, and emerging markets will be 5.5% of GDP compared to what they would have been. So, whatever growth forecast we had in December 2019, for the next 4-5 years economies will be producing between 3-5% less than that…
China is the only country that bucked the odds. If you take China out of the equation, all developed and emerging markets, even in 2021, will not be at their 2019-level output. Even when we talk about India, you have to say what will GDP be two years from now and compare it to what we thought GDP would have been pre-Covid.
On the impact of India’s measures from April to mid-October
Well, there’s been a lot of measures… We’ve seen RBI constantly roll out new instruments, there was regulatory easing, we saw forward guiding introduced for the first time in India. I am sure at some point we will talk about trade-offs that the RBI may face if inflation is sticky. On the fiscal side, the government has made a conscious approach to go about this in a step-wise manner. One rationale could be that as the economy opens up, fiscal multipliers get higher and we can spend.
Now, the question is that there will be permanent damage to India as well — how much firepower do you save for later, how much firepower do you use for now? My own view is sooner rather than later, because think of what the objective is — you want to prevent economic non-linearity, you want to prevent firms from going bankrupt, you want to provide income support to households, and you want to backstop the financial system. The trade-off is that on the one hand the later you wait, maybe you get a higher fiscal multiplier, but you want to act soon enough to prevent these non-linearities because that hurts the productive capacity of the economy.
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On why a 10% contraction is expected when all indicators suggest recovery on course
Remember, much of that 24% contraction in April-June was because the economy was shut down. So, as the economy opens up, we’ll expect a rebound. The good news is that we’re seeing a pretty strong rebound, particularly in goods and industry. Number two, the infection rate in India continues to get lower, so some of that fear premium has gone away, and you are seeing households gradually begin to normalise their activity. If you look at the household consumer confidence surveys, for the first time since September households are a little bit more optimistic about the future one year out, versus where they were in July.
Now, we need to interpret this data very carefully, at least for three reasons. One is, some of this could just be pent-up demand — the global economy in the third quarter is growing at 35% annualised, but the fourth quarter will be 7%. So, we may well be seeing that households will spend in September-October what they would have otherwise spent in April-August. So let us see if this sustains.
The more important point is, remember services are 55% of GDP and what we are measuring — mainly exports, imports, freight, cargo — these are all goods, and around the world you are seeing that the goods sector is recovering much faster than the services sector. If you look at hotel services, professional services, construction services, these are recovering much more slowly.
The last point I’ll make is, ultimately we have to ask ourselves, two years from now, where will India’s GDP be? That will depend crucially on the hysteresis in the labour market and the financial markets. On the labour markets, we still need to be a little bit worried and vigilant.
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On when hotels, tourism, restaurants, aviation — the worst-hit — can hope to recover
I think we’ll have to open in a calibrated and intelligent manner. Europe opened too soon, people got too relaxed, now they are seeing a huge surge in infection. In the services sector, I think the opening will be far more calibrated. I think we will learn to live with social distancing, we’ll learn to live with masking, but it’s only when there is a vaccine and the fear completely dissipates that human behaviour will go back to normal.
Where growth can come from if services remain subdued
Consumption growth in the last five years has been very strong, 7%. But what’s less appreciated is that a lot of that consumption was driven by households running down savings and taking on debt. The key to future consumption is the perceived permanence of the shock. That’s what we are seeing in the household surveys already. Households are telling us, going forward, I will be marking my consumption down, my savings will likely go up. Households perceive permanent income as being hit, so don’t expect consumption to go back to the same 7-8% growth that we saw pre-pandemic. Exports will also be choppy. So if consumption and exports are not giving you much final demand, then it is hard to expect private investment to be booming…
Paradoxically, even in the next couple of years, the government may have to drive growth. Now what do I mean by that? My personal preference is a large infrastructure push, from the next Budget we need a big infrastructure push, the government spending to drive growth. Why is this so important? Because infrastructure has very high multipliers of the economy, infrastructure will boost aggregate demand and hopefully crowd in private investment. It will fill some of the jobs vacuum. Infrastructure also boosts potential growth, so there is a good reason in my mind for the next two years for growth to be driven by infrastructure. The million-dollar question is, how do you pay for it, given all the fiscal issues we spoke about? In my mind, the obvious answer is aggressive asset sale. There is no shortage of assets to sell in India — infrastructure assets, land assets, public sector enterprises… This is a good time to do it.
On whether the government could risk a higher fiscal deficit
I think it is a tricky question because of where our starting points are. With a fiscal deficit of 10% of GDP and debt-to-GDP at 72, India does not have unlimited fiscal space. Now, India’s fiscal deficit will increase by about 4.5 to 5% of GDP, so we keep saying that there is no fiscal stimulus, but deficit goes up by 4.5% of GDP. In ordinary times you would look at that increase and say, that’s a fairly substantial fiscal injection…
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On how to make the most of the current account surplus expected this year
An economy’s current account surplus is nothing but the savings-investment balance and by running a surplus what we’re saying is that savings-investment surplus of the private sector, households and corporations is higher than the savings-investment deficit of the government and the public sector. In other words, India has excess savings at this point because of a current account surplus, about 1.5% of GDP. Now, capital flows have been very strong, so the balance-of-payments surplus is actually 3.5% of GDP — excess savings available to the economy. So what are banks doing? They are essentially buying government bonds. You have got excess savings, banks have this liquidity, and they are going to buy government bonds because they don’t want to take credit risk to lend to real economies… So in a way this is a safety valve for the economy, because it means that if you have the extra savings, the bad news is, it is symptomatic of weak aggregate demand. A current account surplus means aggregate demand is very weak. The good news is that it gives you space. If policymakers decide to have more fiscal stimulus this year or early next year, there is space in the economy to absorb that without the RBI having to monetise that deficit and confront difficult trade-offs.
Whether this window of opportunity should be used now rather than later
My personal view is, yes. I think around the world you need to see two kinds of fiscal responses. In the crisis here, it’s about keeping the patient alive, it’s about making sure aggregate demand is strong enough to keep these small/medium enterprises alive. We’ve done a very good job on credit, but remember what credit does. SMEs who get credit, that allows them to pay salaries and other costs, but ultimately it also increases debt levels, ultimately economic viability comes down to revenues. So if the government can boost aggregate demand, which then spills down into small/ medium enterprises, their economic viability increases. So I would do what’s necessary in the remaining part of this year. Next year, think about infrastructure but finance that through asset sales.
On whether the government should intervene with wage subsidies
The question again is, how do you target, which firms do you target? Do we have data for informal firms? The credit guarantee was available to SMEs that had already borrowed, what about SMEs that hadn’t borrowed? I think the important point about wage subsidies is that they provide certainty of income and therefore precautionary savings will go down if people have certainty of jobs. But it is a supply side issue, ultimately a firm will only hold on to labour if revenues go up and aggregate demand goes up. So we need to do what will boost aggregate demand. If SMEs can see revenue demand, revenues are strong, demand is strong, it will be in their interest to hold on to their workers.📣 Click to follow Express Explained on Telegram
On the risk of possible stagflation in India
Why is inflation being so sticky? I think there are two elements to this. One is that in the last 3-4 months, core inflation actually went up from below 4% to 5.5%. The good news is, over the last three months, the momentum of core inflation has begun to fall…
The worry is more on the food front, where we’ve seen very sticky food inflation for the last 12 months. But again the hope is that over the next 4-5 months, food inflation will come down. A lot of the RBI’s ability to support the bond market and support growth is predicated on the fact that inflation over the next six months comes down from 7% plus towards four percent in the second quarter of next year. Let’s hope that that happens because if food inflation stays sticky and there is any evidence of that spilling into core, then that’ll really complicate economic management further.
Where government should be spending in infrastructure push
India is one of those countries with such a large infrastructure deficit that the question should be, where shouldn’t it be. If we are going to position ourselves as joining global value chains, as having exports drive growth, then you want to have infrastructure connecting the hinterland to ports. Health infrastructure will need a big boost, public health facilities, urban infrastructure need support… I think there is no shortage of infrastructure opportunities here. Now again, this is easier said than done. There are last-mile implementation challenges, land acquisition is an issue, you have to find shovel-ready projects, so I am not arguing that you can build infrastructure in two quarters and boost aggregate demand now. I am just saying that if the private sector is going to take time in then the next 12, 18, 24 months to recover, then we should have a large public works programme, find shovel-ready projects and execute that.
Transcribed by Mehr Gill
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