National Council of Applied Economic Research
The trinity of Covid-19 restructuring of Yes Bank and fall in oil prices amidst the current slowdown marks the onset of Spring Fever in India that we would rather not have. The trinity of factors has made a precarious economic situation worse. While the recent sharp drop in oil prices can act as a benign supply shock the Yes Bank shock will dampen demand via the credit and consumption channels negatively impacting consumer sentiments and eroding confidence. Covid-19’s impact is both a negative demand and supply shock. India will also suffer a contagion effect if the shutdown in Italy spreads to the rest of Europe leading to a global financial slowdown. Wednesday’s decision to quarantine India taken after a thorough assessment will isolate India in more ways than one.
The real GDP had fallen from 8.7% in Q3FY18 to 5.6% in Q3FY19. The growth rate stayed virtually unchanged at 5.8% in Q4FY19 before falling to 4.7% in Q3FY20. Gross Fixed Capital Formation exports and imports of goods and services had shown negative growth rates for both Q2 and Q3 in FY20. Consumption expenditure showed higher growth in Q3 but it was government consumption and not private consumption that showed the y-o-y momentum.
On the supply side industrial growth fell from 8.1% in Q4FY18 to 0.1% in Q3FY20. Manufacturing saw a recession in Q2 and Q3FY20. The services sector showed mixed trends but slowed to 3.5% in Q3FY20.
This overall gloomy scenario did have some green shoots. Agricultural growth trended up growing at 3.5% in Q3FY20. Three lead indicators—tourist arrivals aviation passenger traffic and services trade—were bright spots in Q3FY20. Service exports’ y-o-y growth increased from 1.5% in October 2019 to 12.3% in December 2019. Service imports’ y-o-y growth increased from 3.8% to 11.1% in the same period. Tourist arrivals grew at 5.4% in Q3FY20 versus 2.1% in Q3FY19 and 2.3% in Q2FY20. Aviation passenger traffic showed a turnaround in Q3FY20 with domestic and international traffic growing at 4.9% and 3.2% respectively. The Nikkei PMI Manufacturing and Services indices showed positive growth in both January and February 2020. The IIP showed improved y-o-y growth in January 2020. After growing from 2.2% in January 2019 to 7.6% in January 2020 retail inflation showed some moderation in February 2020. Merchandise exports and imports showed positive y-o-y growth in February 2020 after July 2019.
Brent oil price fell from $71.2/bbl in April 2019 to $55/bbl in February 2020. On March 6 2020 it was $45.37 before falling to $34.4 on March 9 and recovered marginally on March 11. Lower crude oil prices will have a benign impact on inflation the fiscal deficit and the trade deficit. Both retail and wholesale fuel price inflation increased in January 2020. The government could pass on the lower prices to invigorate demand or earn more revenue and lower its fiscal deficit. The Yes Bank saga adds to the financial sector’s ongoing turmoil.
As Economics in the Time of COVID-19 (Baldwin and Mauro) points out the virus will act via “cross-border flows of goods services know-how people financial capital foreign direct investment international banking and exchange rates”. If the Sensex’s downward movement and the depreciating exchange rate are any indication India is already caught in a virulent web.
In India Covid-19 will likely affect the precisely the aforementioned green shoots—foreign tourist arrivals aviation passenger traffic and final consumption expenditure. With the government restraining expenditure till mid-March to control fiscal deficit it is unlikely that public administration defence and other services will see sudden improvement in growth. However that may change in Q1FY21. The two largest sub-sectors in the services sector—trade hotels transport communication and services related to broadcasting and financial real estate & professional services—are likely to see further fall in growth. Hence the sector which already saw low growth in Q3FY20 is likely to slow down further.
In manufacturing economies are likely to be affected by what Baldwin and Mauro call a ‘supply-side contagion’. Indian manufacturing and exports and imports of merchandise were already showing negative growth (excepting February 2020). Although its participation in global value chains is limited India imports a significant share of intermediate inputs from China and is bound to get caught up in this contagion effect. Even if China recovers the non-synchronised slowdown of Covid-19 will affect supply chains. Further social distancing in the second half of this month will affect manufacturing activities adversely. In agriculture and allied activities Indian poultry industry and buffalo meat exports are already showing signs of stress.
On the demand side PFCE investment and exports and imports will most likely continue to show muted growth. GFCE may go up depending on the policy route the government decides to take.
In the midst of India’s economic slowdown this trinity of factors has added fuel to the fire. Fuel prices remaining low might come to our rescue but this is just a quick fix; policy must be reassuring and enable long-term economic decisions. An expansionary fiscal policy could invigorate domestic demand. With muted inflation from benign oil prices expansionary monetary policy could help India recover if accompanied by credible structural reforms at the central and state level for long-term recovery and lifting investor sentiment. Difficult times have been shown to spur action in the past and the time is here again. Already the videoconferencing by SAARC countries shows cooperation is possible. India is likely to remain caught in coronavirus’s international contagion till H1FY21. The question is if India can use this spring fever to turn its economy around and emerge stronger.
The writer Bornali Bhandari is Senior fellow NCAER. Views are personal