IMA Analysis

Saturday May 2, 2020

Badly Shaken May 2020

Speaker:  Adit Jain,Editorial Director, IMA India

Shaken or Stirred

As expected, the easing of the lockdown will now take place in stages. Some parts of the country, identified as containment zones, will remain constrained for longer but in others, human activity would reopen cautiously. The risk really stems from the possibility of a second wave of infection, which authorities would desperately like to avoid. It is hard to say how things will play out and no plans can be cast in concrete, as a crisis of this sort has never happened before and, understandably, governments will have to play things by ear. But one thing has now become clear – the economic impact of the pandemic is much worse than what may have previously been predicted. There remains a very real risk that the economy will slither into a plunge that may be hard to escape from.

In conversations with clients on our forums, it has become evident that industry will go through an extended phase of anguish with uncertainties about demand and recovery. The automotive sector is convinced that consumption trends, that were in any case subdued before the crisis, will be even worse off in the coming months. Many dealerships are unlikely to reopen and consumer demand will be fragile, due to economic and employment ambiguities. Some suggest that production will fall to about 25% of installed capacity. Other segments of manufacturing may be somewhat better off, but managers would insist on a strict vigil on demand trends and set response strategies based on evolving scenarios. Then there will the challenge of worker shortages. The majority of migrant labour, that is still stuck in cities, will in all likelihood return to their villages at the first opportunity. These constitute the bulk of contract employees, daily wage earners who perform very important functions in both manufacturing and logistics. The movement of cargo into and out of ports may remain affected.

Going forward, some of this will have an enduring impact. First, labour costs will rise unreasonably, due to supply and demand considerations and industry will be forced to look for new ways to automate and lessen dependence on people. Many companies have already begun thinking about this and with tweaks in the manufacturing process, noticed they can produce up to 70-80% of installed capacity with a workforce reduction of 40-50%. Obviously, such figures will vary based on products, but the principle remains that the dependence on people will be substituted by machines. At the other end of the spectrum, white collar salaries may actually fall and new jobs are going to be hard to find. Most companies have suspended increments for this year.

The big worry would really be amongst those companies that have exposure to sectors where a recovery may take time to happen, such as airlines, hotels, fashion exporters or small enterprises with limited capitalisation buffers. These are unlikely to limp back in a hurry and with high fixed and variable costs, may crumble under pressure to service their debt and salary obligations. Non-performing assets will jump within the banking system, spreading a financial contagion risking the entire economic structure. This is a serious problem and needs to be carefully addressed by the Government and Reserve Bank. In the first instance, the RBI must modify norms that pronounce an asset to be non-performing, to allow for debt restructuring to take place where firms are given a period of grace, based on individual merits and vagaries of their industry segment. Second, they must be explicitly allowed to send their employees on furlough until demand is revived. If this does not happen thousands of companies will go under, killing entrepreneurship. Hundreds of thousands of jobs will be lost forever. A consequence would be an unforgiving shock to the economic system whose consequences will last for over a decade. The government and other regulators therefore need to act quickly and decisively because, in a response strategy, timing is everything.