India's economy: Always darkest before the dawn?

In late March of last year, one of the world’s strictest lockdowns to curb the spread of Covid-19 was introduced in India, wreaking havoc on economic output. Industrial production declined almost 60% in April, while the services side of the economy dropped over 20% in April–June. While stronger government spending limited the overall fall, in the first quarter of FY 2020 the Indian economy posted the first economic contraction since the country began publishing quarterly GDP reports back in 1996.

Although dynamics gradually improved from Q2 FY 2020 as the restrictions were lifted, a persistently high new Covid-19 case count through the summer and early autumn, reverse migration of workers from major urban areas back to rural regions and insufficient fiscal stimulus limited the strength of the recovery. Estimates put direct Covid-19 relief spending during the pandemic between 1.5–2.5%, with room for maneuver constrained by the government’s weak fiscal metrics amid flagging revenues. FocusEconomics panelists now expect the Indian economy will shrink a massive 8.5% in FY 2020, while a provisional estimate released on 7 January by the Ministry of Statistics and Programme Implementation sees a 7.7% contraction.

That said, economic conditions have brightened markedly in recent months—as evidenced by PMI data—and the Indian economy, home to roughly 1.38 billion people, is expected to rebound robustly in FY 2021 (April 2021–March 2022). FocusEconomics panelists see private consumption expanding roughly 12% as increased consumer confidence, reduced lockdown measures and pent-up demand spearhead a recovery in household spending. Moreover, the services sector will also benefit from increased foreign demand and tourism—hinging on a successful global vaccine rollout. Meanwhile, the government has belatedly opened the spending taps in an FY 2021 budget aimed at boosting capital outlays, which should also provide a much-needed boost to growth next fiscal year. FocusEconomics panelists see GDP expanding 9.8% in FY 2021, which would mark the strongest pace of economic growth on record.

Even more positively, the hardship wrought by the pandemic has led to a sudden spurt of activity on the structural reform front, with the government targeting changes in areas ranging from labor laws and agriculture to the banking sector. If implemented, these changes could boost the growth outlook for many years to come. That being said, downside risks do linger amid uncertainty over the evolution of the pandemic, a fragile fiscal position and a patchy track record on structural reforms.

• The vaccine rollout: A colossal undertaking

The government plans to vaccinate roughly 300 million people—or around a quarter of the population—by July, which, if achieved, should support both business and consumer confidence at the start of FY 2021. While health experts believe the country is already approaching herd immunity in major urban centers without vaccines, vaccination remains a necessary action for the economy to fully reopen due to the possibility of new variants of the virus emerging. That being said, progress so far has been slow, with only a tiny fraction of the population vaccinated by mid-February. This is likely in part due to the country’s vaccine diplomacy efforts: India has distributed millions of doses for free to countries around the world.

• The government steps up capital spending

On 1 February the government unveiled its FY 2021 union budget, which is predominately aimed at supporting economic growth through increasing capital expenditure—by over 30% year-on-year. While this should provide a meaningful boost to private sector activity and will improve economic prospects over the medium term, the underlying investment push by the central government is less impressive than the headline figure suggests, and total expenditure is only expected to rise a mere 1.0% next fiscal year, which would represent the softest increase in total expenditure on record.

Another key upshot of the budget is reduced spending on rural consumption, likely due to expectations of workers migrating back to urban centers as the impact of Covid-19 lockdowns fades—a strategic move to enhance the effectiveness of fiscal spending. The government is set to rein in the fiscal deficit in FY 2021 to 6.8% of GDP from a record of 9.5% this fiscal year, according to Ministry of Finance estimates. FocusEconomics panelists see the fiscal deficit narrowing to 5.8% of GDP in FY 2021.

• Structural reform blitz underway

Since the outbreak of the pandemic, the government has announced a raft of market-friendly structural reforms, such as the privatization of two state-owned banks and an insurance company, market-based agricultural and labor reforms, and changes to its educational polices and rural property ownership laws. Overall, although these reforms are not expected to provide a short-term spark to economic activity, they set the stage for a more inclusive and stable business environment in both urban and rural regions of the country, which should be welcomed by investors.

That being said, the implementation of these reforms will likely aggravate the current beneficiaries of the old system and backlash will be inevitable, although the extent is uncertain. For example, farmers began to protest back in August last year due to the removal of agricultural produce market committees, as this seemed to deprive farmers of a minimum income given prices would now be determined by market dynamics rather than the committees themselves. Moreover, the government has a patchy track record of passing reforms, which leaves some experts pessimistic on its success this time around. Meanwhile, poor infrastructure—the World Bank estimates the infrastructure gap at USD 1.7 trillion—will continue to impede growth.

The government’s ability to expedite and successfully embed these reforms will be key to determining whether the Covid-19 crisis—which caused severe economic hardship to many Indians—could end up marking a positive turning point in the country’s development trajectory.

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.

Author: Steven Burke, Economist

Date: March 25, 2021