Conclusion Papers

Monday August 31, 2020

Indian Economy

In conversation with Adit Jain, Chairman and Editorial Director, IMA India

As the human and economic costs of Covid-19 intensify, it has become obvious that – unlike with the SARS pandemic of 2002 – the recovery will not be V-shaped but more hesitant. In the backdrop of supply chain disruptions and restrictions on cross-border movement, the IMF expects global GDP to contract by 5% or more this year, with America shrinking by 7%, Europe by 8% and Japan by 1%. In comparison, China is projected to grow by a modest 1%. In sheer scale, perhaps the only viable comparison to this crisis is the Spanish Flu of 1918-19, which infected 500 million people and killed 50 million, including 6 million Indians. For India specifically, Covid will diminish both its medium-term growth prospects and investment attractiveness. Businesses will need to develop a line of defense to navigate through a period of slower growth and manage stakeholder expectations accordingly.

   Covid-19: the business impact 

The BCPI has ‘recovered’, but from historic lows   

The recovery will be long-drawn    

IMA’s decade-old Business Confidence and Performance Index (BCPI) is a good lead indicator of business performance and economic growth. It had fallen from 50.4 in Q4 (Jan-Mar) of FY20 to an all-time-low of 20.6 in Q1 (Apr-Jun), but made a remarkable recovery to 46 in Q2. The macro-economy index, which fell to an unprecedented 14.3 in Q1, has rallied to 54.1. Likewise, the business performance index moved up to 45.8 after sinking to 20.9. Although these numbers indicate confidence in an eventual recovery, the outlook for business remains recessionary. Indicatively, the capex index, at 33, is still deep in the red.

Profitability has taken a knock…   

…but the sectoral impact is varied    

The most visible impact of the crisis has been on profitability, with 71% of BCPI respondents anticipating negative profit growth in the first half of FY21 and 47% expecting a decline in the second half as well, coupled with lower sales. Sector-wise, government spending is keeping infrastructure segments afloat, while a good winter harvest and normal monsoon are bolstering agriculture. However, businesses catering to non-essential goods have taken a hit as consumers scale back on discretionary spends. Segments like hotels, travel and other ancillary services remain subdued and have seen major job losses. The logistics and e-Commerce sectors have started to stir up with the gradual reopening of the economy.

The return to normal will take a year or more    

45% of companies expect it to take 6-12 months for demand to return to ‘normal’ (i.e., pre-Covid levels), while 32% believe it will take much longer. A majority of companies have been operating with under 50% of their staff at the office, albeit with comparable efficiency levels and only a marginal decline in the output. In the long term, the average business plans to have ~20-30% of the workforce permanently working from home. Consequently, HR departments are now considering restructuring of compensation packages and figuring new ways to measure productivity.

There has also been a cut-back in office luxuries and new hiring has largely been frozen. Salaries too have started correcting. Anecdotally, the top priorities for business leaders include keeping up workforce motivation levels in a virtual ecosystem, constant communication and the adoption of digital technology. Expectedly, in the backdrop of a volatile economic climate, many organisations have stopped providing forward guidance to their investors.

   Macro-economic indicators… 

Q1 GDP could shrink by 15%, and both demand and supply chains will take time to recover    

Recent data hint at the scale of the crisis that has hit the economy. According to the April IIP numbers, industrial output shrank by 55%. By a rough estimate, each week of lockdown costs India about Rs 2 trillion, or 1% of GDP. Factoring in 2 months of lockdown, plus the impact of job losses and salary cuts, Q1 (Apr-Jun) GDP should be expected to shrink by at least 15%. Going forward, 20-30% of small businesses may not reopen and, with the enormous wealth destruction that has taken place, consumption is unlikely to recover soon. There is a strong correlation between financial wealth and consumption, in particular of big-ticket items such as cars, appliances, furniture and travel. Thus, even as industry hesitantly recovers, demand will remain suppressed for at least two years.

   …and the forward view

On current trends, IMA’s projections indicate the following:

Full-year growth will be negative…   

  • GDP will shrink by 5% or more in FY21 and will start to slowly recover the following year.

…job losses will be significant…   

  • In the base case, job losses will be in the region of 30-60 million. In the best case, they may be limited to 20-30 million jobs while in the worst case, they could go as high as 100 million. As a result, as many as 200 million people could slip into poverty.

…inflation is likely to rise…   

  • Inflation is likely to perk up. Currently, the RBI expects prices to remain subdued, largely on the assumption that demand suppression will override all other factors. However, the likelihood of further fiscal stimulus, together with constraints on the supply side, are likely to put upward pressure on inflation.

…as will banking and NBFC NPAs   

  • Non-performing assets (NPAs) today are officially in the region of 8-9%, but in reality, stand at about 12-13%. In the months ahead, factoring in loans by NBFCs, the overall NPA ratio could jump to 20-24%. This will limit the financial system’s ability to lend, and banks will continue to park huge chunks of their money with the RBI.

Internal transfers will slow…    

  • Remittances from the big cities to rural India and small towns will slow to a trickle in the short term, impacting consumption. Over time, however, migrants will return to the cities for work.
  • Foreign portfolio investments will be volatile and possibly negative for the year as a whole. In contrast, FDI inflows will stay in the region of USD 50 billion.

…and consumption will suffer    

  • Consumption will fall across all groups of consumers. Hit by job losses, salary cuts and the negative wealth effect, the middle class will refrain from non-essential spends. Meanwhile, small business owners, badly dented by the lockdown, will have huge debt obligations to service, and will hold back on spending. Clearly, the poor and the ‘newly poor’ will be among the worst affected, and will spend only on necessities.
  • The current account, which has historically been in deficit, is likely to move into surplus this year. From (-) USD 24.5 billion in FY20, it may touch (+) USD 10 billion on the back of shrinking imports and low commodity/oil prices.
  • The rupee is likely to remain stable, trading in the range of 74-77/USD on the back of a current account surplus – unless investors scurry back to the safety of the Greenback. Despite all the panic at the start of the pandemic, the rupee fell by just 5% between January and July – mostly due to FPI outflows. Several other emerging market currencies did much worse.

Stressed balanced sheets…   

All four balance sheets of the economy are stressed   

Ultimately, the strength of any economic system is linked to four sets of balance-sheets: those of households, corporations, banks and the government. If any two of these are stressed while the other two remain healthy, it is possible for the economy to continue growing. In India, though, all four are currently in distress. Household disposable income growth has stalled. The government is running a huge deficit, and is in no position to do much more pump-priming. Many SMEs have been in trouble for years and a large number of them will probably go belly-up in the next few months. Finally, even as the largest private-sector banks are in good shape, many others have seen a surge in NPAs. Fixing these issues will take years, and will require serious reforms in the land, labour and capital markets. In the meantime, economic growth will suffer.

…and fiscal constraints   

India’s fiscal deficit is much larger than the official numbers indicate and there is little room for additional spends   

Officially, India’s fiscal deficit was 4.6% of GDP in FY20. In reality, it was in excess of 9.7%. The headline figures only account for the deficit of the Government of India, and exclude those of the state and municipal governments, and the debt held by PSUs and quasi-government agencies like the Food Corporation of India and the Indian Railways. Factoring all of these in, the total deficit is likely to jump towards the 15% mark this year. Unlike rich countries such as America, there are limits to the government’s borrowings in India – which are already ~30% higher than comparable countries in the same stage of development. In the next 12-18 months, the debt-GDP ratio could rise from ~60% to ~85%. This could trigger a ratings downgrade – India is just one notch above junk status right now – and cause economic growth to slow further. (At high levels of debt, less efficient government spending tends to crowd out private spending and investment.)

China border tensions 

India’s border tensions with China have taken a turn for the worse. Since the 1962 war, China has occupied large parts of Ladakh’s Aksai Chin region, though the two sides have largely maintained their positions along the Line of Actual Control (LAC). The LAC itself mainly follows the Johnson Line, which defines the border as agreed upon in 1947. Now, for the first time in decades, China has crossed into parts of Indian territory that were never in contention. There could be several reasons for this. First, India has constructed a new road along the LAC, allowing armoured vehicles to move there quickly. Second, India has built air-strips in the region, permitting its fighter jets to land there. Third, China is uncomfortable with India joining the bandwagon of nations opposed to China’s rise. India has sided with the West by joining the Quad and is also supporting the investigation into the origins of Covid-19. China’s actions are in line with its long-running ‘salami’ tactics, under which it grabs a bit of territory, waits for a (non) response, and then grabs a bit more.

In the past, India has tended to segregate economic and military issues, to an extent where different arms of the state acted at odds with each other. For instance, the GoI awarded a Rs 1,200 crore contract to the Shanghai Tunnelling Company, for a bid only slightly lower than one offered by L&T. BSNL contracted a Chinese firm to store its data on the cloud. From all indications, the response to the latest provocation will be stronger and more ‘wholesome’, integrating trade and investment issues with geopolitical ones. India’s huge trade deficit with China – currently in the region of USD 60 billion – will be carefully examined. In all likelihood, India will review, and possibly cancel, a range of existing contracts with Chinese companies.

Keeping an eye on history…   

The UPA’s experience during the GFC is a cautionary tale – and one that the NDA will seek to avoid repeating   

To a large degree, the government’s policy response to the crisis has been guided by India’s experience during the 2008-09 Global Financial Crisis. At the time, the UPA ramped up the deficit by as much as 4% of GDP. This propped up growth for 2 years but, thereafter, growth slumped again. More critically, inflation spiked (touching 12% and staying elevated for years), the rupee collapsed (from 43.5/USD in 2008 to 62.3 in 2014), and the fiscal deficit took years to wind down. In many ways, as the NDA is well aware, this contributed to the UPA’s electoral loss in 2014. The government understands that a spending binge would eventually drive up inflation (even if demand suppression limits the near-term impact), and cause the rupee to depreciate. It is therefore erring on the side of caution, and keeping some dry ammunition ready in case the situation worsens. Moreover, keeping in mind the political fallout of rising job losses and poverty, most new spending will be directed towards the poor. Direct support to industry will be small to non-existent. To finance the rising deficit, the government will have to use some mix of reduced expenditure (capex will be the first to go), increased borrowings and some degree of debt monetisation.

Rising nationalism – and shifting supply chains   

Covid has accelerated the shift away from liberalism and is reshaping supply chains…    

Covid-19 has accelerated a trend that was visible even before the crisis hit: a move away from a liberal world order towards nationalism. Exemplifying this are Brexit, conflicts between the Hanseatic League and southern European countries, the growing rift between China and the West and the gradual hollowing-out of multilateral organisations like the WHO, WTO and UN. Hand-in-hand with this shift, global supply chains appear to be transforming, from hyper-efficient and globally connected ‘just in time’ systems, to ones that are more local and less efficient, but more resilient. Until recently, many believed that these twin factors would lead wary MNCs to move en masse away from China. These predictions may prove exaggerated.

…but any ‘exit’ from China will take years to materialise   

The fact is that China remains the largest exporter to 65 countries and the most critical supplier to 5 million companies across the world. Apple, Hyundai and other major corporations rely heavily on China, which accounts for 25-30% of the global value-add in manufacturing. Given the current climate, many future investments by MNCs may get diverted to other Asian economies, including Vietnam, Taiwan and Japan. Some European MNCs may also relocate plants back to Europe in an effort to reduce the dependence on China. Yet by any account, China’s massive manufacturing clusters and its globally-integrated supply chains mean that, for many years ahead, China will remain a primary force in global investment and commerce.

The contents of this paper are based on discussions of The India CEO Forum with Adit Jain, Chairman and Editorial Director of IMA India, in July 2020. Please visit to view current papers and our full archive of content in the IMA members’ Knowledge Centre, accessible via the Login link on top of the page. A podcast version of this paper is available IMA Forum members have personalised website access codes.