A recovery interrupted

This first of a two-part essay assesses the emerging economic fallout of the second wave

After a very challenging two months, India’s second wave appears to have peaked, with new cases and the positivity rate trending down in recent days. But the national Reproduction Factor has fallen below 1 not per chance or the culmination of some natural cycle, but instead by the progressive application of restrictions across states to reduce mobility and slow the virus’ spread. Google mobility, for instance, is down more than 40 per cent since the start of April and currently at levels seen a year ago, when the national lockdown was in effect. This dynamic is also visible in the cross-section: states that forced down mobility more strongly have, in general, also seen a larger drop in positivity rates. 

This is a stark reminder that until a critical mass of vaccinations is reached, policymakers will continue to confront difficult trade-offs between containing the virus and preserving economic activity. The immediate challenge for states is to decide on re-opening strategies. How quickly or broadly should states re-open? Is there a case to be more conservative this time? There are no easy answers. Instead, it will have to be a case of crossing the river by feeling the stones, and making judgements based on data and science.

The obvious follow-up is to ask what the economic fallout of the second wave will be. Quantifying costs is challenging at the best of times, but particularly so when lockdowns have been so heterogeneous in depth and breadth. That said, there’s growing evidence the impact will not be trivial even if not of the same scale as the first wave. By the middle of May, power demand was down 13 per cent and vehicle registrations were down 70 per cent compared to the start of the quarter, while e-way bills in the first half of the month were at 40 per cent of where they should be. A broader composite index would suggest activity is tracking a 6-7 per cent sequential decline this quarter and, while this is much shallower than the 25 per cent sequential contraction witnessed last year this time, the fact that it comes on the heels of the first shock, and can potentially trigger more hysteresis, remains a source of concern.

The certainty of rising uncertainty? Differences with the first wave, however, don’t end here. While the near-term pothole will be smaller, uncertainty could linger for a while. When the economy began unlocking last summer, and especially once cases had peaked by September, there was a sense among economic agents that Covid-19 was in the rear-view mirror. It was that comfort and confidence that likely drove the strong rebound in subsequent quarters. This time is likely to be different. The suddenness and sheer viciousness of the second wave could inflict behavioural scars for the coming months, till a critical mass of vaccinations is reached:

• For starters, policymakers are likely to become more conservative on the restrictions front, with states re-opening relatively slowly and incompletely this time around and clamping down early at the first hint of renewed pressure

• Household income uncertainty and precautionary savings can be expected to rise. Even before the second wave, households had signalled caution about future spending (manifested in the RBI Consumer Confidence Survey) likely reflecting both an income hit and a precautionary savings motive. This behaviour is consistent with labour market dynamics wherein the unemployment rate, once adjusted for reduced labour force participation, had increased meaningfully even before the second wave. Pressures have only increased since then. For example, by the second week of May, the employment/population ratio had dipped to levels seen last June. While some of this should abate when restrictions are loosened, the added income and health uncertainty could keep households cautious till a critical mass of vaccinations has been achieved. 

• Private investment could also take time to pick up. Even before the second wave, utilisation rates were in the mid-60 per cent range, much lower than needed to jumpstart investment. With the second wave creating both dema­nd and supply uncertainties, private invest­ment will take time to recover, notwithstanding the significant easing of monetary conditions.

Therefore, even as the proximate economic hit in the April-June quarter will be much smaller than the first wave, the rebound could be more gradual given elevated levels of uncertainty.

Global tailwinds and headwinds: To be sure, there are silver linings to the outlook as well. For starters, the coming quarters should see the strongest global growth since the Second World War, as developed markets reap the dividends of aggressive vaccination programmes, unprecedented fiscal stimulus and easy monetary conditions.

We have previously found a strong elasticity of India’s exports to global growth and, if that holds, this should drive a strong export rebound in India. Some of this is already visible in the data with manufacturing exports surging in recent months, and currently 18 per cent (in nominal dollar terms) above pre-pandemic levels. Exports, more generally, could become a key growth tailwind in the coming quarters.

There is, however, never a free lunch. Booming global growth has also contributed to a strong and sustained commodity price rally. Crude prices, for example, have jumped 60 per cent over the past seven months. If crude prices average close to $70 this fiscal year, as is expected, that would constitute a 50 per cent increase over last year and serve as a negative terms of trade shock that impinges on household purchasing power and firm margins — a process already underway.

That said, if the global economy does grow at the expected 6.5 per cent rate this year — a 10 percentage point improvement from last year — and domestic supply chains are not disrupted such that the previous relationship between global growth and exports holds, the export impact should offset the negative terms of trade from higher crude, making the global impact a net positive.

Contextualising the recovery: Putting the different pieces of the puzzle together, 2021-22 appears to be on course to growing at about 9 per cent — less than previously envisioned on account of the second wave — on the back of an expected 7.5 per cent contraction last year. How should one put these sharp swings in some context?  

When all is said and done, the completeness of an economy’s recovery from Covid-19 — and therefore the level of scarring — is assessed by comparing its post-Covid-19 path of the level of GDP with the path forecasted pre-Covid-19. If the aforementioned forecasts fructify, the level of quarterly GDP at the end of this year would be about almost 8 per cent below the level forecasted pre-pandemic. To be sure, India will not be the only emerging market to be below its pre-pandemic path. In fact, among the large economies, only the US and China will surpass it. But that said, an 8 per cent shortfall is meaningful.

The question, therefore, is how should economic policy respond to this second shock? With fiscal and monetary policy already quite expansive, is there space to respond further? We assess policy options and tradeoffs in a companion piece tomorrow.

Sajjid Z Chinoy is Chief India Economist at JP Morgan. All views are personal. The second part will appear on Tuesday