The environment has turned around remarkably in November. This is due to several positive developments. On the pandemic front, the steady decline in infection rates, a visible reduction in public fears and risk-aversion, and the low possibility of reversion to past stringencies for containment have been important contributors. Then, the brightened prospects of a vaccine-led recovery, although still distant, have uplifted global spirits that have transmitted to buoy domestic markets too.
On the economic side, India’s economic recovery turned out better than expected in the September quarter where some notable developments are the outstanding corporate results, surprising decrease in banks’ NPAs with low debt-recast demand by firms, steady normalisation of activities, buoyant indirect tax collections, and some fresh stimulation measures from the government to top this all. Externally too, apart from the successful results of three major vaccine research trials, world trade volumes are now expected to decline less this year (9.2 percent) than in April (12.9 percent); while the recovery in world output growth was better than expected in July-September.
All these positives lit up business sentiments, improved consumer confidence, and raised the possibility of an earlier positive outturn in this quarter, with some growth upgrades.
The reading between the lines is more sobering. First, the extraordinary profit growth of 2,500-odd listed companies comes with contracting sales volumes and revenues, and arises chiefly from severe cost-cutting, including inputs. There’s a depressing side to this robust performance because suppliers sold less goods while employee numbers reduced. This means lower value added and incomes elsewhere. Or that aggregate demand isn’t correspondingly as strong. The overall effects will reflect in the July-September GDP data due at this month end.
The decline in consumption could be disproportionate because the divergence in profit and wage growth represents increased inequality. These are poor portents. It remains to be seen how temporary the layoffs are; how soon, and if, the increased profitability of large firms converts to investment or capacity expansion.
Manufacturers are still uncertain how much of the sales represent pent-up demand; remain cautious on restocking, and have mostly reserved assessments of demand beyond this current quarter.
Second, a continuation of the health and economic crisis poses a risk that a growing share of unemployment will consist of people in persistent joblessness, slowing the overall recovery in forthcoming quarters. This especially applies to services, which display more subdued recovery trend, and where wage costs are a relatively higher fraction of the total.
Moreover, the urban worker engagement levels are very high in the personal and contact-intensive services such as hospitality, recreation, retail, tourism, etc. These are still struggling because of the pandemic and are either not operating or operating much below potential. The pandemic has not left the landscape yet so the growing sense of having ‘shaken-it-off’ warrants caution from both the government and the public.
Three, the enlarged slack in the labour market ought to restrain the transmission of food inflation, where the anticipated decline has not materialised so far, and is complicating macroeconomic risks. Even though surplus labour pressures are likely to prevent a rise in core inflation, the elevation and rise in food inflation will bear down upon consumption.
Four, the fresh bank failure (Lakshmi Vilas Bank) and the third one in two years remind that the financial sector risk persists, and can escalate with additional stress from the pandemic. For now, bad loan outcomes may seem to defy RBI’s July (Financial Stability Report) predictions — the baseline estimates a 4 percentage point rise in one year to March 2021 at 12.5 percent — as firms consolidated, sold assets and repaid loans.
But it deserves flagging that regulatory moratorium is holding back some stress, loan defaults currently concentrated at the nonbanks and fintech firms could extend with a lag, especially if a slow-paced recovery tests financial resilience of vulnerable firms and lessens the abilities of healthier ones to withstand prolonged stress.
Finally, the sustenance of external recovery remains unsure. Most foresee a weakening European recovery in the last quarter as a result of the recurrent virus outbreaks and restrictions with that of the United States and China sustaining. But the readings can change as suddenly as the COVID-19 course has been seen to.
With these warnings, a continued growth out of the April-June trough amidst the pandemic is to be hoped for.
Renu Kohli is a New Delhi-based macroeconomist. Views are personal.
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