Making sense of the recovery

The recent economic acceleration is encouraging, but below the hood, palpable risks still loom

After a difficult few quarters, India’s public health and economic landscape is witnessing a discernable inflection. India’s new daily cases, deaths and positivity rate have all halved since mid-September. This should elicit much relief, but not complacency. The dramatic resurgence of the virus across Europe and the United States just confirms that as soon as countries let their guard down, another vicious wave is upon them. Daily cases around the world are now the highest since the pandemic began. Daily deaths have doubled over the last month and are poised to rise ominously. 

So while equity markets are gripped by the vaccine euphoria, the reality on the ground is much more sombre. It could be a long and dark winter for the West. The economic fallout is already becoming manifest. European growth is poised to contract again, pulling the global economy’s annualised growth momentum to just 3 per cent this quarter, after the 40 per cent rebound last quarter. The lessons for India are clear. First, we cannot let our guard down, and mustn’t let complacency or the festival season trigger a second wave. Second, a stalling global recovery will soon pose external headwinds. 

Glass half full

That said, the slowing of the virus in India has reinforced the economic recovery. Several silver linings are emerging. First, activity appears to be back to almost 90-95 per cent of pre-pandemic levels. Consequently, the contraction in July-September GDP is expected to narrow to a better-than-expected 8 per cent. Second, the early news emerging from the financial sector is encouraging. Banks’ collection efficiencies have ranged from 90-98 per cent, higher than expected, alongside a lower demand for restructuring loans. Prima facie, this would suggest the damage to the real economy and financial sector balance sheets could be less than feared. But crucial caveats exist, as we discuss below. Third, the credit guarantee scheme to SMEs has induced banks to finally lend to SMEs and the government has now extended the guarantee to 26 stressed sectors. More broadly, bank credit grew sequentially in October after contracting for the previous two months.

The usual caveats 

But it’s important not to get ahead of ourselves. First, the usual caveats. As is the case around the world, the initial rebound often has a significant pent-up demand component to it. So we need to be patient to see how demand evolves after the initial burst. Also, it’s important to distinguish between final demand and inventory accumulation for the festival season. Within the auto sector, for example, output gains have largely resulted in higher inventories. Auto registrations (a proxy for final demand) are still running about 20 per cent below last year. Finally, on asset quality, it’s too early to make strong judgements. NPAs develop over time, and borrowers have accumulated balances from the moratorium. So it should not be a surprise that collection efficiencies are high for now. Remember, the financial sector is a lagging, not leading, indicator of the recovery, so the real test is ahead of us. 

Glass half empty 

Data interpretation apart, a more fundamental concern is growing risks of scarring in the labour market. CMIE surveys suggest the employment rate is still about 2 percentage points below pre-Covid levels, translating into 9 million fewer jobs today. After improving for several months, the employment rate has plateaued at these levels since September. This is qualitatively consistent with a sluggish recovery of employment within the PMI surveys and with 11 million more rural households seeking MGNREGA employment in October compared to a year ago. 

What all this suggests is the labour market is lagging the economic recovery. This also syncs with the nature of the recovery in the July-September quarter. Operating profit growth of listed non-financial firms sizzled (+44 per cent in nominal terms) but largely on the back of firms rationalising expenditures. Recall, on the income side, GDP is simply the sum of economy-wide operating profits, pre-tax wage incomes and indirect taxes. If GDP is poised to contract in the July-September quarter, yet listed company profit growth is so strong and indirect taxes are recovering quickly, what does that tell us? That profits of smaller, unlisted firms and labour income (wages and employment) suffered a sharp contractions last quarter. This, in turn, could have meaningful implications for future growth and income inequality.  

Illustration: Ajay Mohanty

To be sure, job creation typically lags economic recoveries. Employers first need more conviction about revenue and profit sustainability before hiring again. But we need to remain very vigilant about labour market scarring because it will have crucial implications for future consumption, output and retail asset quality. In recent years, household consumption has been increasingly financed by households running down savings or taking on debt. If job-market pressures induce households into perceiving the Covid-19 shock as quasi-permanent, their impulse will be to save, not spend, going forward. 

Measuring the recovery

Finally, and stepping back, how should one assess the eventual impact of Covid-19 on an economy? Across economies, 2020 will elicit sharp growth contractions followed by sharp rebounds in 2021. What does this tell us about the completeness of the recovery or any permanent damage inflicted by Covid? 

Very little, until one looks at the level of output in the coming quarters. In particular, does the post-pandemic path of output levels eventually converge with the forecasted pre-Covid-19 path? If so, the recovery can be deemed to be complete. There would still be a potentially large wealth effect — the sum of the lost output/income in the quarters before activity retraces its post-pandemic path — but no running income/output losses thereafter. In contrast, if the level of output post-pandemic consistently stays below the pre-pandemic path, there would be a permanent loss of running output.

In India’s case, Bloomberg Consensus forecasts peg GDP to contract 9 per cent in FY21 before rebounding 8.5 per cent in FY22. 

If these were to fructify, however, the level of output in March 2022 would still be a meaningful 11 per cent below the level projected pre-pandemic, suggesting much catch-up will still be left to do. While this scenario is not unique to India, it signifies the gravity of the challenge ahead. 

The recent acceleration of economic momentum is undoubtedly encouraging. But we shouldn’t get ahead of ourselves. Even as we get closer to a vaccine, it could be a year before a vaccine has a material macro impact in most emerging markets. From an economy’s perspective, that’s an eternity. In the interim, flooded by liquidity, equity markets will continue to hum to a buoyant tune. But on the ground, much will still need to be done.

The writer is Chief India Economist at J P Morgan. All views are personal