Doubts blur post-unlock recovery amid whiff of inflation

Decoding the economic data from April until now offers insight into the probable path of return to normalisation. Trends indicate that the swift and steep rebound observed after April’s slump to June is unlikely to sustain as several indicators have begun to level off this month.

One, a more likely trajectory is an uneven, elongated ascent with intermittent slipbacks and even then, economic activity may not return to pre-COVID-19 levels as long as infections abound.

Two, the weakness of recovery in services portends that anticipated losses in GDP could be higher if infections increase as they are.

Three, a resurgence of core inflation in June despite collapsing demand aggravates uncertainty about the extent of supply disruption and the output gap.

Overall, these trends indicate raised risks to growth and point to a need for speedier containment of COVID-19 infections. Further, developments on the core inflation side underline the need for greater clarity by policymakers on the quantum of output contraction expected in 2020-21.

Most April-June activity indicators such as electricity and fuel demand, mobility indices (Google and Apple), Purchasing Managers Index (PMIs) for manufacturing and services, growth in industrial output (April-May), exports and non-oil imports, labour participation rates (CMIE’s surveys), sales of two- and four-wheelers and tractors, among others, showed a sharp rebound on reopening after the lockdown slump of April — annual contractions eased and sequential (month-on-month) momentum rose while GST revenues increased at a sequential 47 percent in June over May’s 92 percent jump and from April's low of Rs 323 billion. The strength of resumption was placed about three-quarters that in February or pre-COVID-19 levels by end-June.

However, fortnightly developments in July have thrown a spanner in the V-recovery. Moderating mobility, power demand, sales reported by producers and retailers relative to those in June, GST e-way bills, other consumption markers show visible signs of plateauing. This probably owes to a rise in public fears and risk-aversion due to the sustained, three-fold rise in infections relative to early June as the virus spread to new geographies; fresh and re-imposed local shutdowns add to supply constraints. The pattern is not surprising or restricted to India. It is also observed in the United States where recently the Federal Reserve Chairman is worried about such levelling off.

Besides indicating an uneven and prolonged recovery, the fallback underlines the need for speedier and more concerted efforts to contain the outbreaks. Policy focus must be trained upon containment, for it is clear that COVID-19 is here to stay even as there is no more a choice between infection outbreaks and economic reopening. This also ties with the depression in services, where the PMI recovery to 33.7 in June from April’s 5.4 has lagged all other countries. Increasing infections are a poor growth portent if 54 percent of aggregate output, engaging nearly one-third of the workforce either informally or through self- and contractual-employment, cannot meaningfully recover because it is more susceptible to infection risks and vulnerable to consumer fears of contagion.

Moderating business activities also pose a downside risk to revenues, e.g. derailing the recovery in GST collections, which could tighten the cord on public spending. Central and state governments are leaning heavily upon fuel taxes, but the dependence is fragile, besides hurting demand. Further, if it compels upward revision in GST rates -- officials recently hinted a revisit as revenue-neutral rates are too low -- a perverse configuration with depressed consumption would be undesirable. This is another reason why authorities should step up efforts to reverse the rise in infections.

Does the rise of core inflation bind monetary policy? It is too early to determine if this is temporary, driven by supply shortages against returning demand, fuel price hikes, or imputed values by the statistical agency, which qualified interpreting the data accordingly. At its last review meeting (May 22), the RBI expected heightened inflation uncertainty in the first quarter, with deflationary forces subduing supply factors thereafter to pull down headline inflation below target in the second half of 2020-21.

However, the unanticipated jump in core inflation has escalated uncertainty, which is unnerving. It urges a need on the central bank’s part to shed clarity on the size of the output gap. The RBI has already indicated that output will contract this year, but the complications arising from the core inflation side impress urgency for specifying the quantum of output contraction it expects. This quantification is now essential to give an idea about the size of the output gap, and the consequent monetary space available to address the new uncertainty. The output gap seems severe for most institutions and private forecasters have drastically lowered their growth estimates.

Since the situation now is one in which infection outbreaks and reopening will come up in uncertain and uneven doses, the best course for policymakers is to reduce the odds with as much support and clarity as possible.

Renu Kohli is a New Delhi-based macroeconomist. Views are personal.