India’s economic recovery is being characterised by three distinct forces that need to be disentangled. First, India has broken the link between virus proliferation and mobility earlier and more successfully than many countries. Rising mobility and normalising economic activity, rather than sparking another wave of infections, have coincided with COVID cases falling by 80 per cent since September. India’s cumulative death toll per million is now less than half the emerging market average, and an order of magnitude below developed economies. Consequently, the progressive return towards pre-COVID activity levels has occurred much sooner than expected. Activity jumped back up to 95 per cent of pre-COVID levels by October, and has been inching up since. This is being complemented by the much-awaited pick-up in central government spending, which surged in November and is expected to remain strong for the rest of the year. These dynamics should reduce the full-year growth contraction to 6.5 per cent, less than the NSO’s advance estimate of 7.7 per cent and much less than previously feared.
These are very hopeful developments but, juxtaposed with a stronger-than-expected recovery, is confirmation of labour market scarring. CMIE’s labour market survey still reveals 18 million fewer employed (about 5 per cent of the total employed) compared to pre-pandemic levels. The employment rate gradually improved till September but has weakened since then, even as the economy has progressively opened up. This also shows up in the PMI surveys where employment is lagging activity, and in demand for MGNREGA jobs which are still 50 per cent higher than the previous year. These labour market pressures increase risks of medium-term economic scarring, and are not incompatible with a sharper near-term rebound because the recovery appears to be led by capital and profits, not labour and wages. Even within labour, blue-collar workers are likely to have been disproportionately impacted vis-à-vis their white-collar counterparts.
A third phenomenon is large firms have endured the crisis better and are gaining market share at the expense of smaller firms. To the extent there is a migration of activity from the informal/SME firms to larger firms, tax collections and Sensex/Nifty earnings should get a boost, even holding the economic pie constant. It’s, therefore, important to interpret the data carefully because some variables will reflect this substitution effect as much as the pace of the recovery. Greater scale and formalisation undoubtedly augur well for medium-term productivity but could increase near-term labour market frictions and boost pricing power.
All this, therefore, increases prospects of a K-shaped recovery from COVID, a phenomenon playing out globally. Households at the top of the pyramid are likely to have seen their incomes largely protected, and savings rates forced up during the lockdown, increasing “fuel in the tank” to drive future consumption. Meanwhile, households at the bottom are likely to have witnessed permanent hits to jobs and incomes. These cleavages are already visible. Passenger vehicle registrations (proxying upper-end consumption) have grown about 4 per cent since October while two-wheelers have contracted 15 per cent.
What are the macro implications of a K-shaped recovery? With the top 10 per cent of India’s households responsible for 25-30 per cent of total consumption, one could argue consumption would get a boost as this pent-up demand expresses itself. But it’s important not to conflate stocks with flows, and levels with changes. Upper-income households have benefitted from higher savings for two quarters. What we are currently witnessing is a sugar rush from those savings being spent. This is, however, a one-time effect. To the extent that households at the bottom have experienced a permanent loss of income in the forms of jobs and wage cuts, this will be a recurring drag on demand, if the labour market does not heal faster.
Second, to the extent that COVID has triggered an effective income transfer from the poor to the rich, this will be demand-impeding in the steady state, because the marginal propensity to consume at the bottom is higher than that at the top, just as the marginal propensity to import at the top is higher than at the bottom.
Third, if COVID-19 reduces competition or increases the inequality of incomes and opportunities, it could impinge on trend growth in developing economies by hurting productivity and tightening political economy constraints.
Policy will, therefore, need to look beyond the next few quarters and anticipate the state of the macro economy post the sugar rush. The key, of course, is whether the private sector starts re-investing and re-hiring, and thereby sets the economy onto a more virtuous path. Barring that, the labour-market hysteresis could sustain. With manufacturing utilisation rates below 70 per cent pre-COVID, an investment revival, in turn, will depend crucially on the demand dynamics. Exports should benefit from strengthening global growth as the world gets progressively vaccinated and the Georgia-induced blue wave results in more US fiscal stimulus. But will this be enough to stoke a private investment revival? Or will firms look through the next few quarters and remain cautious given the still elevated uncertainty?
It’s against this backdrop that the upcoming budget presents India with its New Deal moment. An unprecedented infrastructure push under the New Deal in 1935 created millions of jobs and regenerated regional economic development in the US. India must seek inspiration from this. Given the prevailing demand uncertainties, the budget represents an opportune moment for the Centre, in conjunction with the states, to embark on a large physical and social (health and education) infrastructure push. The benefits are self-evident. This will simultaneously boost near-term aggregate demand, crowd in private investment, create jobs to soak up the unemployed, and improve the economy’s external competitiveness. Job creation, health and education, in turn, will be a start to help mitigate COVID-induced inequalities.
The question is: How will this be financed? With the consolidated fiscal deficit projected above 11 per cent of GDP, gradual near-term consolidation coupled with a credible medium-term fiscal plan will be key to anchoring the bond market and underscoring an adherence to macro stability. How then can public investment increase meaningfully if the headline deficit must come down? Only if the public investment push is financed by aggressive asset sales (strategic sales, disinvestment, land and infrastructure monetisation). In this manner, expenditure to GDP can actually rise next year — generating an expansionary fiscal impulse to the economy — while automatic stabilisers (a normalisation of tax revenues next year) are used to reduce the headline fiscal deficit.
India’s faster-than-expected rebound is very encouraging. But given labour market pressures and prospects of a K-shaped recovery around the world, the economy will need to be carefully nurtured and stoked. The budget presents a crucial opportunity to make a big down payment towards this end.
This article first appeared in the print edition on January 11, 2021, under the title “India’s new deal moment”. The writer is Chief India Economist at JP Morgan