As India’s economy embarks on a new financial year, a dark cloud is on the horizon: The second wave. Every day brings further reconfirmation that the second wave is no longer a Maharashtra-centric phenomenon. With the daily run-rate of cases surpassing the first-wave peak, it’s no longer just a wave, but a potential tsunami. Yet, there is a silver lining — the number of daily deaths is currently around half of what it was during the first wave peak, offering some relief to the health infrastructure, and consequently reducing the urgency of states to rush into lockdowns. However, as cases rise, this relief may prove short-lived.
The second COVID-19 wave comes at a time when India’s economy has made a resilient comeback. But with the spectre of lockdowns again looming large, how much does the second wave threaten this recovery?
There are a few reasons why we aren’t raising a panic at this point. First, the lockdowns are far more benign than they were during the first wave. While select contact-based services and transportation are likely to be hit, they remain operational at lower capacity levels. The rest of the economy — agriculture, industry and even services such as construction, communication, trade — should remain largely unaffected. Our estimates suggest that the sectors “at-risk” account for less than 6 per cent of the economy. Second, firms and consumers have rapidly adjusted to the new normal and the relationship between (lower) mobility and (weak) economic activity has been weakening over time.
The ultra-high frequency data for March and early April, released since the renewed lockdowns were announced, seem to largely corroborate this. While power demand, ozone concentration levels, and railway freight revenues have remained relatively resilient, there is a dip in driving congestion and railway passenger revenues. Google retail and recreation mobility, while mostly holding up on aggregate, have shown greater drags in Maharashtra, and a slow moderation in states like Punjab, Madhya Pradesh and Gujarat. The Nomura India Business Resumption Index, our weekly tracker of the pace of economic activity normalisation, is tracking around 9 percentage points below normal after almost returning to pre-pandemic levels in end-February. Hence, the second wave has resulted in a marginal hit to services activity, but the goods sector continues to recover.
There are bright spots to look forward to over the coming quarters. First, the pace of vaccinations is likely to accelerate further — we estimate that India is on track to vaccinate 40-45 per cent of its population by end-2021. As vaccinations pick up, they are also likely to result in an “ultimate unlock” of the economy as the services sector bounces back. Second, we expect a synchronised global growth recovery to begin in Q2, led by the US, which should have some beneficial growth effects on India. Historically India’s growth cycle has moved in sync with the global cycle due to trade and investment linkages. And finally, the lagged impact of easy financial conditions on the resilient formal sector households and firms is still to play out.
We expect real GDP growth to remain positive and rise further in Q4 2020-21. However, a worsening second wave implies that sequential momentum in Q1 2021-22 would likely be weaker, although year-on-year growth will still be above 30 per cent this quarter and overall growth in 2021-22 should be above the RBI’s projection of 10.5 per cent.
Nevertheless, there are risks and uncertainties to monitor. The virus could mutate and the speed of vaccinations could waver. Higher commodity prices-led terms of trade deterioration could squeeze firms’ profit margins and/or consumer real incomes, if passed on. Higher US yields and the risk of capital outflows could prematurely tighten domestic financial conditions.
Over the medium term, it remains to be seen if India’s fiscal activism will lead to a revival of the private capex cycle or if firms’ remain focused on debt deleveraging. With the smokescreen of forbearances finally lifted, this year will present a clearer picture of the extent of balance sheet scarring.
These factors weighed on the RBI during its April policy meeting, where it maintained policy rates and its accommodative stance, without changing its GDP growth outlook for 2021-22, while projecting headline inflation above 5 per cent for most of the fiscal year. To manage the yield curve, it is now experimenting with Federal Reserve-styled Quantitative Easing. It is a tough juggling act — to support growth with ample liquidity, manage long term yields, and yet stave off the inflationary impulse by-product. One of the balls has to eventually drop.
As for what happens next, we believe the RBI is particularly monitoring two dials on its dashboard: One, the economic impact of the second wave and two, whether cost-push pressures lead to higher core inflation. While the second wave has rapidly rivalled the first wave in terms of its magnitude, unlike the first tsunami, growth should have a much firmer footing this time around. There may be a few uprooted trees, but the foundations of the cyclical recovery are likely to remain strong, in our view. Once these risks recede, we expect a clear signal on policy normalisation to emerge with a higher weight to inflation, relative to growth. We expect explicit liquidity normalisation (implicit has already started, in our view), the policy stance to shift to “neutral” from “accommodative” in July-September, the normalisation of the policy corridor to take place in Q4 2021 (via a 25 bps reverse repo rate hike) and 50 bps worth of repo rate hikes in the first half of 2022. This gradual normalisation of liquidity and policy, alongside absorption of government borrowing, will call for careful communication and deft policy manoeuvring.
This column first appeared in the print edition on April 10, 2021 under the title ‘Swimming above the wave’. Varma is chief economist for India and Asia ex-Japan, and Nandi is India economist at Nomura.
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