Worst over; GDP growth will recover faster than forecasts in FY22: Arvind Virmani

Indian economy's GDP growth will recover from Covid-19 shock sooner than expected
Revival in economic activity, consumer confidence will see GDP growth recovering faster in second quarter of FY22 than anticipated by forecasts.

By Arvind Virmani

GDP growth to recover fast: It is useful to compare Covid-19 second wave with the first wave in analysing its effect on the Indian economy. However, this analysis is incomplete unless there is a better understanding of the speed and severity of the second wave compared with the first. It also requires an understanding of Pandemic and lockdown economics. Essential goods were exempted in both the lockdowns. Therefore, it is unlikely for agriculture sector to be affected in states.

This time around, the global and Indian agricultural prices are much higher than in the previous year. This will have a positive effect on agriculture sector despite an increase in input prices as terms of trade are clearly better. The second factor is the rise in real wages. Both these factors are positive for the rural economy in financial year 2021-22.

Conventional wisdom is that the Covid-19 second wave would follow the same pattern as the first wave. But recent studies show that the second wave was faster and much more virulent in terms of number of cases and deaths and will, therefore, subside much more sharply and quickly than the first wave. Hence, there may be an upside surprise to the economy and we can conclude that agriculture will do better than in first wave, after an initial hiccup.

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Unemployment during Covid-19 second wave

In the first wave, unemployment rose to 8.8% in March, 23.5% in April and May and started improving to 11.6% in June as the lockdown was eased. In case of the second wave, unemployment rate rose from 6.5% in March to 8% in April and further to 11.8%. This was half of first wave peak. So, the direct effect of lockdown on production would be about half of first wave as well. The ratio of the urban to rural unemployment rate in the second wave is 1.4 compared to 1.1 in the first wave.

This shows that urban areas have been hit harder than rural areas, contrary to the assumption of most analysts. This is to be expected from our research on the state-wise spread of the mutated virus causing the second wave, which showed that states with higher urbanization have been worse affected than the less urbanized ones.

Due to the high impact of the second wave, pre-existing shortages of skilled labour will be accentuated, which will further negatively affect the speed of recovery of industry & services for which demand recovery is quick. The government should quickly implement the changes in the Apprentice ship Act announced in Budget 2021, and to improve training of semi-skilled workers in cooperation with industry.

Contact services (hospitality, entertainment, tourism) would take much longer to recover because of the reality and the fears of infection, particularly in indoor venues and badly ventilated locations. The government needs to incentivise improved ventilation in outdoor venues as well as indoor public spaces, factories and offices; installation of high-quality air filters in air-conditioned halls, and buildings and ultraviolet (UV) ceiling lights in crowded small rooms (pubs, bathrooms, kitchens, and restraints).

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Consumer confidence and GDP growth

The precautionary savings of household are expected by many analysts to increase post second wave, and thus delay the recovery of private consumption. There are three other factors, one negative and two positives, that need to be considered to derive the net effect on consumption. The consumer confidence (RBI survey) fell from 86 in March 2020 to 50 in September 2020 and recovered to 55.5 by January 2021, to decline to 53.1 in March. This will be a negative factor in the speed of recovery of private consumption after lockdown.

Interestingly, the gap between the current and future expectations index has more than doubled since pre-Covid days and may result in a fast reversion in current expectations, once it starts. Institutions providing consumer credit (e.g., NBFCs) are in a much healthier position than they were 18 months ago while demand from corporations for bank credit is low, given higher internal savings. So, consumer credit will aid recovery.

There was no vaccination in sight through much of the first wave. There are now several approved vaccines, including two produced in India, with several more on the way. The planning and management problems which have slowed vaccination will be solved. So, the medium-term income growth trend is much more positive than during the first wave. Both these factors will offset the desire for more precautionary savings and boost GDP growth.

As our research had predicted, post lockdown, the manufacturing-mining-construction sectors recovered rapidly after supply chain disruptions were addressed. Given the geographically and sector-wise limited nature of the current lockdown, supply chain disruptions will be more limited in India, and with the recent experience of already dealing with them, the recovery will be rapid. Supply chain disruptions are more widespread across the world. This will increase oil prices, which will have a negative effect on the national income and growth.

As usual, the oil price impact will be partly offset by higher exports and remittances. Therefore, we can clearly state that the supply chain disruptions and short-term adjustments in demand (e.g., diversion of demand from contact services to goods, because of contagion fears) will lead to inflationary pressures in particular goods or sets of goods. But these pressures are temporary and will subside as Covid-19 contagion fears decline and demand patterns normalise in 2021.

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Economic recovery will be faster than predicted

The GDP growth in the first quarter of FY22 will be lower than projected in March 2021, and investment revival will be delayed by one quarter. As consumption depends on expected income, which is clearly on an upward trajectory in H1 of FY22 as against the downward trajectory in H1 of FY21, this factor will offset the impulse to increased precautionary savings from Q2 of FY22. Recovery will be much faster in Q2 than anticipated by forecasts. FY 2022 GDP growth will remain within the range of 10% +/- 1.5%, even though the downside risk appears much higher at this point than it was in February 2021.

Fiscal deficit is being driven by GDP-linked revenue fluctuations which act as automatic stabilisers. The best fiscal stimulus that the government can provide is revenue neutral or revenue negative tax reform by accelerating simplification of GST towards a single rate (15%) for 75% of goods and services and the introducing a new direct code. Speedy revival of construction intensive infrastructure projects will help normalisation of total employment. Incentives for air filters and UV lights and investment in Covid vaccines will help reduce the chances of a third wave, reduce fears of contagion and restore consumer confidence.

The government can boost GDP growth by implementing the Apprenticeship Act reform announced in Budget 2021 and completing the promised ease of compliance of labour, tax / financial laws and rules. The Union government should also review the laws, rules and regulations affecting start-ups and tech companies to make them competitive compared with peers in locations like Singapore.

The state governments must do their part in simplifying the jungle of controls and regulations imposed by them, and speeding up the vaccination process. The RBI’s monetary policy is and has been on the right trajectory since the start of the pandemic and should continue the same path. Only finetuning of credit policy and government security markets may be needed.

(Dr Arvind Virmani is Chairman, EGROW Foundation, a Noida-based think tank. He has served as India’s representative to the IMF in 2009 and as the Chief Economic Advisor to the government of India. This article is a reproduction of Mr Virmani’s comments at the shadow monetary policy committee, convened by EGROW Foundation.)

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