While global recovery could lift economy in 2021, domestic drivers for growth are still unclear

The good news is that global recovery has already begun, and global GDP is rising. The key risk to the global sequential recovery, however, is the fact that the virus has not been brought under control in the US, and across several emerging economies. Compared to rest of Asia, the situation is strikingly worse in India too, where new cases have accelerated — especially since the reopening began — and now stand at approximately 50,000 per day. This compares with less than 2,000 new daily additions on average in the rest of the region. The situation in India and the US, along with localised outbreaks in several parts of the world, raises the risk of a rise in infections as economies open up further, which might trigger renewed government restrictions or voluntary changes in behaviour that could weigh on growth.

The lockdowns and rising public anxiety about the virus led to a sharp deterioration in economic activity in India. After a deep contraction in the April-June quarter, we expect the economy to rebound mechanically. Going forward, we expect a step-down to a more normal, and lower sequential growth pace. Different parts of the economy are likely to recover from the hit at different speeds. Industrial activity could possibly normalise, especially in manufacturing where controlling the virus might be easier. In contrast, industries in which it is harder — travel or entertainment for example — will still be in a gradual normalisation process, and probably won’t rebound completely until a vaccine is available. Our quarterly estimates imply that real GDP would contract by 4.4 per cent in FY21; this would be the deepest recession India has witnessed since 1980.

Several high frequency economic indicators are displaying sequential improvement, which has likely set in a sense of complacency amongst market participants. What we are currently witnessing appears to be a tug-of-war between improving economic data, and the still escalating virus situation. It is important to note, however, that what we are witnessing is just the normalisation of activity from extremely low levels; this may not be evidence of marked improvements in domestic macroeconomic fundamentals. Overall activity still remains weak. For example, Eway bills — tax applications filed for movement of goods are 25 per cent lower as compared to the same time last year; vehicle registrations are tracking a 45 per cent year-on-year decline; and both Google and Apple mobility trackers reported contraction of 40 per cent compared to normal levels.

The key question that markets are confronted with is — what will be the key macroeconomic drivers of Indian growth going forward?

Discretionary fiscal policy support, defined as targeted support to households and businesses, the kind of policy support that can revive any economy quickly in times of an unprecedented shock like we have seen, is tepid in our view. Indeed, credit rating agencies appear to be less worried about the worsening of fiscal and debt positions in the short-term — in fact, it is the reverse. They appear to be more concerned about the fact that India may not have the administrative and fiscal capacity to implement large fiscal support, and that would be a headwind to growth. What would reassure markets and avoid further credit rating downgrades is not lower fiscal spending in the short-run as many perceive, but most importantly a strategy to revive growth, combined with a credible fiscal plan for the medium term.

Market participants also wonder why India has not seen more aggressive fiscal policy support, not only compared with advanced economies but with other emerging economies too, and given the nature and scale of the shock. One possible explanation — an underlying implication of Viral Acharya’s recent book Quest to Restoring Financial Stability in India — is that fiscal dominance during normal times, which basically allowed the sovereign to run about 10 per cent deficits, implies that the government’s ability to apply countercyclical policy is severely curtailed during a crisis. In the short term, the economy has to pay a price. The price of not saving and investing in an umbrella when there is sunshine is that we have to bear the costs when it is raining.

Monetary policy and the central bank have been the main “game in town”; the RBI has reduced policy rates by 115 bp since the crisis hit, combined with tools to inject liquidity, and regulatory measures. India’s policy rate easing, in fact, remains comparable with the “average” conventional monetary policy support we have seen across emerging and advanced economies. We expect the MPC to reduce interest rates further, even though it decided to pause at its August meeting. It appears that it took a “wait and watch approach” given that inflationary pressures have started to show up in the data; and with the intention to save firepower for the future. Our view is that there is clearly a need to do more, conditional on the evolution of the economy so far, and our forecasts for the rest of the year, and the fact that the support from fiscal policy has been muted so far.

Finally, the exchange rate has remained remarkably stable in this crisis. The RBI’s real effective exchange rate has actually strengthened by 4 per cent since pre-COVID, and would actually be a drag on growth. Therefore, while pent up demand, favourable base effects, and massive policy support in advanced economies driving the global recovery could lift India’s economy in 2021, we struggle to see any domestic fundamental forces to drive India’s growth ahead.

The writer is chief India economist, Goldman Sachs, India