Issues related to Economic growth

 The double whammy that India’s economy now facesop-ed of the day

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not much.

Mains level : Paper 3- How will India economy be impacted by the Covid-19?


Context

India is currently in the grip of dual shocks: Covid-19 and a financial one.

The supply and demand shock

  • Containing outbreak at economic cost: Even as infection rates have tapered in China, they are rising elsewhere. Countries that have succeeded in containing it have done so at an economic cost, by quarantining people, implementing lockdowns and social distancing.
    • This has resulted in a plateauing of new infection cases in China and South Korea, but they are still rising exponentially across Europe and the US.
  • Supply shock: This is both a supply as well as demand shock. On the former, the impact is via disruptions in China-centred supply chains.
  • Demand shock: But there is also a hit to final demand as infections spread across the rest of the world, hurting travel, tourism, hotels and local retail activity.
  • Tightened financial condition: The correction in equity markets and wider credit spreads have tightened financial conditions, and both consumer and business confidence has faltered.
  • Rising infections in Europe a big concern: Rising infections in Europe and the US are a big concern as both are large services-driven economies. Any pullback in their consumption demand will likely result in a demand shock for the rest of the world.

Global spillover of Covid-19

  • Hitting economies in waves: One uncertainty pertains to how long this shock will last. There are no definite answers as of now. Covid-19 shocks are hitting economies in waves and countries are imposing lockdowns, one by one.
    • Hence, instead of a synchronized global slump over one or two months, the economic impact is getting spread out.
    • For example, supply chain disruptions and lockdowns in China are gradually easing, and we estimate that factories should be operating at full capacity by mid-April.
  • Hit to travel and tourism to last till June: The hit to travel and tourism will last at least until June because even if the number of new infection cases eases, travellers will remain cautious initially.
  • Demand in the US and Europe to remain low until April: Curtailment in discretionary demand due to social distancing in the US and Europe only started in March and will likely continue until April, if not longer.
  • Global spillover to continue till May: The global spillovers of Covid-19 will likely be spread out over February and May, implying a weak first half of 2020.
    • Whether the shocks last longer will depend on whether countries successfully contain infections.
    • It also depends on the ability of countries to prevent spillover effects onto corporate balance sheets (more defaults) and the labour market (job losses).
  • Global GDP to remain low in the first half: Global gross domestic product (GDP) growth in the first half of 2020 is likely to be weaker than during the global financial crisis of 2008-09, due to a sharp first-quarter decline in China, and weaker  final demand in developed economies in the second.

What will be the impact on India?

  • The economic hit to India will be felt through multiple channels.
  • First, India is not a part of China-centric global value chains, but China accounts for a significant share of India’s imports (14%) and its production halt will hit India’s imports of
    • primary and intermediate goods,
    • disrupting domestic production,
    • particularly in industries such as pharmaceuticals, auto, electronics, solar power and agriculture.
  • Second, there will be a slowdown in international and domestic travel and tourism. India earns over 1% of GDP as foreign exchange earnings from tourism annually.
  • Third, social distancing measures, along with the public fear factor will hit domestic retail activity as people avoid public places.
  • Fourth, India will face the indirect effects of weaker global demand, tighter financial conditions and low confidence.
    • Oil windfall offset: Even though lower oil prices are a boon, in the current environment any benefit from lower oil prices will be offset by other negatives.
  • Domestic financial sector risk: Another big challenge for India relates to domestic financial sector risks.
    • The spillover effect of Yes bank: Weak growth and financial stability concerns have been brewing for over a year now and the spillover effects of Yes Bank’s takeover are still reverberating through the system.
    • The fallout of the shadow banking slowdown via potential stress for real estate developers and small and medium-sized enterprises is a risk.
    • If the asset quality of both shadow banks and the banking sector deteriorate in the next few quarters, as is likely, then domestic credit conditions may stay tight, as the perceived risk premium could rise further.
  • GDP growth rate: In this backdrop, the real activity could suffer. The GDP growth is expected to average around 4% year-on-year in the first half of 2020, with risks skewed to the downside.
    • GDP growth in 2020-21 is unlikely to be more than 2019-20’s 5%.

Way forward

  • An optimal policy response to Covid-19: The optimal policy response to is globally-coordinated public health safety and virus containment. India has taken some worthy decisions on this.
    • Since Covid-19 will adversely impact service sectors like retail, hospitality, travel and civil aviation, the government’s fiscal policy response should be aimed well through measures such as tax relief and interest-free loans, particularly for small and medium enterprises.
  • Liquidity easing and policy accommodation: On monetary policy, a combination of liquidity easing and policy accommodation would be needed beyond the moves already made.
    • Macro-prudential steps such as lowering the counter-cyclical capital buffer for banks could be announced.
    • Fixing the financial sector, though, would need a broader response, including a recognition of the full scale of the problem and then adequately recapitalising banks and shadow banks.
    • Else, credit risk premia may stay elevated and credit growth may not pick up.

Conclusion

In all, the economic impact on India due to shocks emanating from Covid-19 could get compounded due to weak domestic balance sheets. The coming quarters call for close vigilance of credit risks and the prioritizing of financial stability.

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