Updated: July 22, 2021 8:03:13 am
Now that there is evidence of high levels of seroprevalence in the population, with nearly 80 per cent of the most vulnerable (those above 45 years of age accounted for 90 per cent of Covid deaths) having antibodies, economic opening up is no longer a distant dream. It is time then to look at India’s economic output in a full year without any activity restrictions.
In economic forecasting, trend is a good friend: In “normal” times, collective human behaviour tends to be somewhat predictable. The reason estimates of economic output from different firms are so remarkably close is not just the innate human urge to conform (“herd behaviour” among forecasters), but also that economies have a certain momentum which persists unless some external forces are applied, not unlike the “objects in motion” that Newton described in his laws. Imagine an upward sloping line (called the “trend line”) — and the economic output (GDP) of a country tends to fluctuate around it. If trend growth is 6.5 per cent, growth in a year tends to be between 6 and 7 per cent, and most forecasts would be in that band. Without a significant shock, growth rarely moves outside it. Trend lines also change over time, but usually this is not a sudden change.
The reasons are somewhat simple: GDP in a year equals the number of workers multiplied by output per worker. Workforce changes are driven by demographics and are generally smooth. Output per worker depends on capital investment (like better roads, better medicines or more computing power), improvement in the skills of workers and in the collective knowledge: There is a nice self-reinforcing rhythm to many of these.
But when shocks like Covid-19 occur, and output swerves sharply away from the trend line, these forecasting approaches come unhinged. Take GDP for the June quarter, which fell 24 per cent last year — from 100 in the June-2019 quarter to 76 in June 2020. When predicting the output level for the just-ended June-2021 quarter, should one take it as 18 per cent growth, 22 per cent growth or 25 per cent growth? In other words, will the level of output be 90, 93 or 95? This is difficult.
There are similar challenges in forecasting GDP for the next fiscal year which one can now hope will have minimal pandemic-related restrictions. If GDP in the last pre-pandemic year 2019-20 was 100, then the inflation-adjusted output in 2022-23 is currently forecast to be 108. If there had been no pandemic, at 6.5 per cent growth a year, 2022-23 would have been at 121. So, the current consensus is for 2022-23 output, without any restrictions, to be 10 per cent below the pre-pandemic path.
This is too low, in our view, and can be 113 — 6 per cent below the pre-pandemic trajectory. This implies that the current annual growth numbers for each of 2021-22 and 2022-23 need to be revised upwards by more than two percentage points. Let me now explain why we think so.
Instead of predicting year-on-year growth, we take the pre-pandemic path as the starting point, and then go through reasons why there should be a gap. Given the reduced utility of working with year-on-year growth in these volatile times, this approach may have fewer and smaller errors.
Despite lockdowns, several drivers of productivity like formalisation, digitisation, construction of highways and household tap connections improved last year. Investments did fall, but based on past trends, should shave only about 2 per cent of GDP. A large part of the income lost was socialised over current and future taxpayers (higher public debt), or was for wage-earners, who in aggregate “did not earn, did not consume.” The challenge, of course, is that the people who did not earn were mostly different from those that did not consume. In any case, damage to risk capital was limited, particularly in formal enterprises, as seen in the broad-based profit improvement in listed firms.
Corporate leverage (debt-to-equity ratio in the BSE500) is at 10-year lows and likely to fall further this year. Together with a sharp increase in equity-fund raising, both in the public and private markets, this means that the potential to invest has been preserved. In the financial system as well, the assets-to-equity ratio, a measure of lending firepower, is at strong levels.
While informal firms did get impacted badly, we note that they are concentrated in sectors that are not capital but labour intensive: Transportation, education, personal services, apparel and restaurants. These segments have seen heavy job losses, but whenever restrictions are lifted, jobs and incomes should rebound — think private-school teachers, bus or rickshaw drivers, tourist guides or tailors. While they may have sold assets or taken on debt to survive in the last 15 months, this should not directly affect their earning ability. On the other hand, a goods distributor, whose earnings are more dependent on capital deployed in the business, may see lower earnings if his capital has been eroded. There are fewer households in this latter category.
In education, private schools catering to the middle and low-income households have been the most impacted, together with people employed in education-related transportation. Upper-income households shifted to online schooling, and while education quality suffered, economic activity (fees) and jobs were mostly preserved. At the other extreme, for nearly half the students attending government schools too, the teachers mostly got paid. The damage to economic output from missed education would show up a few years later if not compensated for.
Can there be a problem of demand? Given that the pandemic has left many lower-income households with higher-debt and/or fewer assets, their consumption may be constrained. However, not only is much of their demand non-discretionary, in aggregate, the bottom half of households only consume as much as the top 10 per cent. The latter have been left with elevated financial savings, some of which are likely to be spent in the coming months. Improving penetration of personal loans can further support consumption by all types of households.
The output post-restrictions is, thus, likely to bounce much higher than currently expected. However, it will still be meaningfully below the pre-pandemic path, and policymakers must look to close the gap. An early but safe opening up would help: A district or better, block-wise seroprevalence study would give local administrations the confidence to open up schools and transportation, particularly where seroprevalence levels are already above 80 per cent, and focus vaccination efforts where they are not. Thereafter, the recovery may be accelerated by triggering the expenditure of the surplus savings of the rich on labour intensive services (like travel) or goods (like apparel), say via a short-lived cut in indirect taxes.
This column first appeared in the print edition on July 22, 2021 under the title ‘How high we can bounce’. The writer is co-head of APAC Strategy and India Strategist for Credit Suisse
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