The Economic Revival Debate, Part 2: Battle Won, War Still On

Despite encouraging data, it is too early to celebrate economic revival, as attempts at restoring normalcy in the economy could make the next Covid-19 wave more ferocious, says HDFC Bank's Abheek Barua

By Abheek Barua

Published: Nov 23, 2020 05:06:55 PM IST

Updated: Nov 23, 2020 06:10:09 PM IST

Image: Shutterstock

A raft of encouraging economic indicators suggest that the proverbial animal spirits are back. Are they? Forbes India presents two views. Read another view by economist, author and BJP spokesperson Sanju Verma here

Even the most churlish cynic would find it difficult to question India’s economic recovery since August. A raft of economic indicators ranging from the issuance of e-way bills, railway freight, car-and-two-wheeler sales to more formal indices like the Purchase Managers’ Index point to a sharp climb from the deep trough of this fiscal year’s first quarter when GDP growth had contracted by 24 per cent.

Bits of other news also deserve a whoop of cheer. Despite the dispersion of the coronavirus widely across the country, with the easing of travel restrictions and reverse migration, the infection has not spun out of control in the more vulnerable states like Uttar Pradesh or Bihar whose health care infrastructure lag the national average. The farm sector, the provider of perhaps the most critical input for the economy—food—has been largely resilient. In fact, the summer kharif crop cycle is expected to yield a bumper harvest of 144.5 million tons of food grain. Yet, economists are likely to fret over a couple of things. They are also likely to warn that while the first couple of battles have been won, the long war against the virus is far from over.

Which are the discordant notes in the economic revival tune? For one thing, curbing inflation that has remained uncomfortably high over the last 12 months is emerging as a major policy challenge. Average inflation in the first nine months of 2020 was 6.8 percent, much higher than the upper bound of the RBI’s tolerance band of 2 to 6 per cent. This cannot simply be dismissed as the result of a “supply shock” driven by a temporary spike in prices of some food items. Both its persistence and the fact that it is becoming more broad-based should cause concern. More economic stimulus, be it monetary and fiscal, even if it is imperative to sustain the growth momentum, become risky and can add to price pressures.

Bank credit growth, a key marker of economic activity, is at best tepid with year-on-year growth of 5 percent. This, despite the fact that the government’s decision to guarantee loans to small enterprises under the Emergency Credit Line Guarantee Scheme has done reasonably well. Anemic loan disbursal could mean a couple of things. First, companies and individuals don’t have the appetite for borrowing. Companies borrow to fund expansion (term loans) and to hold inventories of raw materials and finished goods (working capital). It might be unrealistic to expect companies to add to capacity in the middle of a pandemic. However, the weak demand for working capital means that they are simply not confident enough about the future to hold stocks of either inputs or output.

The other explanation could be that banks have become risk-averse and reluctant to lend because the pandemic and its economic damage have increased the likelihood of default. The RBI’s July Financial Stability Report predicted a surge in the non-performing asset percentage from 8.5 percent in March 2020 to 12.5 percent in 2021 under its “baseline” scenario. It is not surprising then then that banks are squeamish about lending despite a sharp rise in deposits.

In fact, risk-aversion amidst the uncertainty about the pandemic’s path has pervaded multiple areas of economic activity and not just banking. The history of epidemics tells us that households tend to “buffer up” their savings in these episodes and companies conserve cash. The government has justified its decision not to make large cash transfers citing this likely behaviour.

Transfers, it has argued, would find its way into bank deposits and other savings instruments and not to the shopkeeper’s till. Thus, as long as economic agents see the prospect of an end to Covid-19, this risk-aversion will keep harnessing demand. Part of this increase in the propensity to save is perhaps to set aside money for treatment should a family member get infected. In fact, Covid-19 related expenses threaten to push poorer households below the poverty threshold.

The current experience of Europe, the US and Indian cities like Delhi and Ahmedabad underscore the fact that we need to be prepared for a second or perhaps multiple waves of the virus. Attempts at restoring normalcy in the economy could actually make the next wave more ferocious. Thus, there is little scope to reduce vigilance or relax containment protocols to any significant degree.

Containment strategies tend to impact two things that are important for economic activity—mobility and congregation. Think of the simple but important example of being able to go to a market and shop along with other individuals. In the lexicon of pandemics, this becomes a potential “super-spreading” event and needs to be curbed. This is bound to hurt consumer demand. Online shopping might have done well, but is far from being a perfect substitute. Limited internet connectivity for one thing (there are less than 50 internet subscribers per hundred in six telecom circles) remains a barrier.

Finally, while the success of pharma giants like Pfizer and Moderna in the last-stage trials of their vaccine could be the clichéd “gamechangers” for pandemic management, the journey from clinical trials to mass vaccination is likely to be long.

India is no stranger to large scale inoculation programmes and has had spectacular success with diseases like polio. However, the rollout of the Covid-19 vaccine will be the first major mass adult vaccination programme with its own unique problems.

There are huge logistical challenges in distributing the vaccine. To begin with, it would require an unprecedented ramp up in the cold chain network. Skilled personnel to inoculate people would have to be marshalled. The division of responsibility between the private and public sector will have to be worked out. The government will have to find the financial resources to purchase and distribute the vaccine and this would bring new fiscal challenges.

Despite the encouraging economic data, it is way too early to climb out of the trenches and declare victory.

(The author is chief economist and executive vice president at HDFC Bank)

Read another view by economist, author and BJP spokesperson Sanju Verma here