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Need Of The Hour: Equilibrium Shift In Indian Economy

Author: Dasari Sreenivasa Rao/Wednesday, December 30, 2020/Categories: Exclusive

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Need Of The Hour: Equilibrium Shift In Indian Economy

Growth trajectory depends on extent of morbidity and mortality, duration of external and internal restrictions, and actual size and efficacy of fiscal and monetary policies; Post-lockdown recovery can either be V-shaped, U or L, says KPMG

The Covid-19 outbreak in India coupled with a series of lockdowns has already slowed down the economy through reduced consumption, production, investment, etc. Covid-19 has had a huge destructive impact on both demand as well as supply forces globally. The global economy including India may move from a high output and employment equilibrium to a low output and employment equilibrium. The overall impact on the economy happens through the demand and supply side channels. On demand side, private consumption and gross capital formation contribute 90 per cent to GDP and both are likely to be negatively affected by the Covid-19 outbreak resulting in an overall economic slowdown, according to KPMG, which carried out a comprehensive study on the 'impact of Covid-19 pandemic on potential income and employment in India.' 

Both exports and imports are likely to fall due to Covid-19. India exported goods contributing 18.7per cent to its GDP in FY20 (in current prices), while imports accounted for 21.4 per cent of total supply, making India a net importer. Exports have been declining for the last six months. Since May 2020, the month-wise percentage fall in imports with respect to previous year, has been greater than that of exports leaving a trade deficit in August of $6.8 billion. The growth of government spending provided some support, but that was far outweighed by the contraction of consumption and investment. "The extent to which Covid-19 will disrupt domestic and global supply chains will be an important factor in determining its impact on the Indian economy. Some key factors from the supply side include labour unavailability, fall in liquidity, capital formation in the market, and, changes in cost of operations resulting from an increase in prices of material inputs, cost of transportation etc. due to input shortages," says KPMG in the report.

The reduction in total output and employment, change in prices post-Covid-19 and overall growth trajectory of India would depend on the extent of morbidity and mortality, duration of external and internal restrictions, and actual size and efficacy of fiscal and monetary policies introduced by the Indian government.

Linear demand and supply curves are assumed in our model. For a given fall in demand, supply may fall proportionally to demand, or fall greater than demand or fall less than supply (see chart). In reality, demand and supply curves will be highly non-linear due to factors such as social distancing measures, belief-based elements of the shocks and disruption of supply chains, but the key point is that the interaction between demand and supply curves will determine net quantitative and qualitative impact on the economy. Given all these factors and scenarios, the recovery post-lockdown can either be V-shaped, U-shaped or L-shaped depending upon the time taken by the economy for a gradual upturn from the existing situation.

GVA Analysis

While the fall in GVA at an economy level is driven by the declining output of all major sectors, some sectors are expected to shrink more, thereby contributing more to this fall at a macro-level. "Of such sectors, our analysis suggests that wholesale and retail trade could be the hardest sector hit followed by real estate and construction. These sectors (trade, real estate, construction, services, etc) largely cater to the non-essential products/services or were significantly impacted by social distancing and hence, were severely impacted during the lockdown. Even after lockdowns have been lifted, the demand of such sectors is likely to remain subdued due to low economic growth and business sentiments and social distancing measures. Since these sectors also contribute largely to the national GVA, even a small decline in output of these sectors affects the economy significantly," further added KPMG.

The decline in GVA of these sectors has been different under the different scenarios as the annual impact of the pandemic could vary depending upon the length of non-essential business closures and the spread of the virus. The results of U-recovery scenario for eigth sectors aggregated as per National Accounts Statistics.

Logistics Cost A Major Hurdle For Industry

India needs to lower its logistics cost to 7-8% of GDP as there is an urgent need for the domestic industry to lower its logistics cost, according to a report by Confederation of India Industry (CII), which recommended a 20-25 per cent reduction in indirect costs.

The CII report observed that the current logistics cost in India is 14 per cent of GDP, while in the US and Europe, it ranges between 8-10 per cent. India's supply chain and logistics sector is one of the largest globally, with a logistics industry of $215 billion, growing at a CAGR of 10.5 per cent.

It suggested that the logistics modal mix should be enhanced with roads constituting 25-30 per cent, railways comprising 50-55 per cent, and waterways accounting for 20-25 per cent. It also said that the cold chain storage infrastructure should be expanded.

Barnik Chitran Maitra, lead author of the report and Managing Partner of Arthur D. Little India and South Asia, said: "Despite its size and criticality to economic growth, India's supply chain faces several barriers to growth, notably an unbalanced logistics modal mix, high indirect costs, fragmented infrastructure and networks, and limited technology adoption. To bridge the current competitiveness gap of $180 billion, India needs to halve logistics cost from 14 percent of GDP to 7 per cent."

Real Recovery In Q4

Industry body PHDCCI says that the continuous improvement in the key economic and business indicators signals that the worst is behind us and expectations of a positive GDP growth at 0.1 per cent to two per cent in Q3 and two per cent to four per cent in Q4 FY 2020-21 are becoming strong with a higher growth trajectory in FY 2021-22 at 7.7 per cent, according to PHDCCI EBM Index (Economic and Business Momentum Index).

"The series of stimulus announcements by the government in last nine months under the Aatmanirbhar Bharat Abhiyaan 1.0, 2.0 and 3.0 along with the calibrated measures undertaken by the RBI have pulled the economy from the lows of Q1 FY 2020-21 (-) 23.9 per cent in Q1 2020-21 to (-) 7.5 per cent in Q2 FY 2020-21. The overall growth for the FY 2020-21 is expected to contract by (-) 7.9 per cent," said Sanjay Aggarwal, president, PHD Chamber of Commerce and Industry (PHDCCI).

The growth trend of PHDCCI EMB Index suggests that economy has potential to rejuvenate at more than 7.7 per cent growth trajectory in the next financial year 2021-22. On a monthly basis, PHDCCI EBMI (Economic and Business Momentum Index) has shown steady recovery from the lows of 78.3 in April 2020 to 85.7 in May 2020, 91.6 in June 2020, 95.5 in July 2020, 95.9 in August 2020, 96.5 in September 2020 and 96.7 in October 2020.

"Steady growth of EBM Index is progressing towards the level of Q4 of 2019-20 as October 2020 EBM Index at 96.7 is very near the level of 97.1 in October 2019. Economy is expected to recover to the level of Q4 of 2019-20 in the coming months of Q4 2020-21," said Aggarwal.

PHDCCI EBM Index is a composite index of 25 lead economic and business indicators with base year at 2018-19, which considers the demand and supply parameters to present a broad perspective of the economy. Out of the 25 lead economic and business indicators, 21 have shown a remarkable improvement in October 2020 from their lows of April 2020.

Strong recovery has been observed in the production of cement, steel, consumer durables and capital goods from the lows of April 2020. In the financial segment, FDI equity inflows have shown a remarkable recovery.

Various international organizations and agencies have forecasted a negative growth for India and have revised the projections further, due to the extended lockdowns and the performance of the Indian economy in Q1 FY2021. IMF and World Bank have projected a contraction in India’s real GDP of about 10.3 per cent and 9.6 per cent respectively over FY20.

The Government of India has announced an economic stimulus package of Rs20.9 trillion to push the economy through significant fiscal and monetary measures. The net impact on output, employment and growth trajectory of India would depend on three main factors-a) extent of morbidity and mortality; b) duration of external and internal restrictions; c) actual size and efficacy of fiscal and monetary policies introduced by the Indian government. Accordingly, the recovery post-lockdown can either be V-shaped, U-shaped or L-shaped depending upon the time taken by the economy for a gradual upturn from the existing situation.

"To evaluate the impact of Covid-19 on India’s Gross Value Added (GVA) and employment, an analytical framework based on a demand-driven Input-Output model has been developed. The overall impact of slowdown has been computed by analyzing the impact of negative shocks on major components of final demand (consumption, investment, government expenditure, net exports) for different sectors of the economy under different recovery scenarios. The economy level shocks (as derived from the sector-specific shocks) on consumption, investment, at the economy-wide level for each scenario. In our model, different negative shocks and recoveries are assumed for different sectors with respect to their final demand components. Higher negative shocks are assumed for sectors such as aviation, hotel and restaurants etc. that are most severely affected by Covid-19, while mild shocks are assumed for essential service sectors like agriculture," said KPMG in the report. KPMG study finds that the Indian economy is expected to contract in the range of 1.1 per cent to 13.6 per cent over FY 20 under different (V, U and L) recovery scenarios assumed for the post-lockdown period.

Policy recommendations

Covid-19 is a global pandemic that has led to a public health crisis with adverse economic consequences. As the disease outbreak is not likely to disappear in the immediate near future, proactive policy actions are required to not only save lives, but also protect the economy. Using the estimated average all-India income multiplier of 1.5, India can get closer to V-shaped scenario by increasing final demand by 7.4 trillion in the U-shaped scenario and 15.1 trillion in the L- shaped scenario. KPMG recommends this required increase in final demand to be met 50 per cent by an increase in the consumption expenditure by way of direct benefits and health related expenditures (over and above 3.1 trillion announced in the economic stimulus) and 50 per cent to be met by increase in the investment (over and above 1.58 trillion announced in the economic stimulus) in the health and critical infrastructure sectors.

India’s GDP was on a slowdown mode even before the coronavirus pandemic hit the country. Covid-19 impedes the growth of Indian economy.

Precautionary steps needed to contain the spread, inflicted further pressure and India’s GDP, as a result, contracted by 22.6 percent at current prices (23.9 percent in constant prices) in 1Q 2020-21.4. While the process of gradually winding down lockdown restrictions helped economic activity, businesses have not been able to achieve their full capacities due to internal supply chain disruptions and shortage in labour, as well as demand weakness. The growth of government spending provided some support, but that was far outweighed by the contraction of consumption and investment, both constitute a large portion of India’s GDP.

Agriculture was the only sector that registered growth in first quarter of 2020-21, as the consumption of essential items had largely been unaffected by the lockdown economic activity showed signs of improvement once the lockdown restrictions were eased, and hence it is reasonable to expect the numbers for the subsequent quarter to indicate better performance. A great deal of key economic indicators point to a recovery from a sharp contraction noticed in the first quarter of 2020-21. This recovery could stay alive with more activities having been opened up, but its pace is likely to be uneven. The relaxation of lockdown measures did help the economy, but the recovery path is currently clouded by the continuous spread of the pandemic and the risk of a second- wave. Thus, it is imperative to subject the potential recovery to various scenarios and understand the resultant impact on key industries, which is the main objective of this report.

The writer is a business journalist with 27 years of experience

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