India’s economy is going great. Can the recovery sustain?

Other indicators such as auto sales, consumer and capital goods output, cement production, steel consumption, and freight traffic have seen strong sequential recoveries though they continue to remain below their pre-COVID-19 levels.

So, the question is how sustainable are these trends and can we count on them?

We now have empirical evidence which shows that COVID-19 vaccine access, vaccination and effective policy support have been the mainstays of recovery in the developed economies. From that perspective, a spate of reformist announcements that include Gati Shakti, sale of long-pending Air India as part of the aggressive asset monetisation plan, scrapping of retrospective taxation, sector specific PLI schemes, and labour as well as agricultural reforms do impart a sustainable medium-term push to the economy.

Importantly, in the near term, the pace of vaccination has played an important role in supporting the pace of recovery, and buoying India’s outlook over the last two months. An average of 7.9 million jabs were administered every day in September, up from 5.9 million in August and ~4.2 million in June-July. This surge has pushed the total dose count to 968 million by October 13 and 77 percent of all adults have received the first dose, while 31 percent have received both doses. At this rate, India could fully vaccinate all adults by the end of this fiscal.

While the sequential recovery in economic activity is encouraging, it has also been supported by pent-up demand, and revenge consumption. These factors have provided a one-off boost, and there is likely to be some exhaustion on this account, which poses downside risks beyond the immediate period. Further, the recovery has been uneven, and is besieged with multiple divergences (k-shaped).

Exports appear to be a bright spot, having grown by 56.9 percent YoY during H1 FY22 and 23.8 percent over H1 FY20 levels. However, this impressive nominal export growth must be interpreted with caution as it has a very strong underlying price element to it. As per the World Bank, global energy and non-energy prices have averaged 104.4 percent and 38.8 percent higher during April-September as compared to year ago levels (this is why India’s imports have also grown quite rapidly, rising 82.3 percent YoY during H1 FY22).

Besides, strong export demand has also been supported by the materialisation of pent-up demand across major economies aided by supportive fiscal policies — these effects are likely to fade going forward. We will still need a lot more evidence to believe that the pandemic has led to a rise in global import elasticity of demand (for India’s exports), and that exports could support domestic growth in a meaningful manner in the medium term.

When it comes to the investment scenario, the situation is still worrisome. As per the CMIE, the aggregate value of new project announcements has slumped by ~15 percent YoY to Rs 3.6 billion in H1 FY22, and is also ~30 percent lower than H1 FY20 levels. This comes on a decline of 54 percent in full-year FY21. That new project announcements have slumped compared to H1 of last year, when the onset of COVID-19 had led to stringent restrictions is quite surprising. This is also worrisome, given that new project announcements in the current period would be critical to support investment demand in the medium term.

The drop in new project announcements has been driven by sectors such as electricity, transport services and construction, and real estate — which are cost heavy, and account for the bulk of the cost of new projects as well as projects under implementation. While a host of capacity additions are likely to come in over the next two years on account of the PLI schemes, these will be concentrated in the manufacturing sector which by itself is unlikely to drive a capex recovery. Recovery in electricity, and services segments such as transport services and construction, and real estate would be critical, given their size, to kick off a sustained private capex cycle.

High inflation, across the world, and in India, also poses a risk to India’s growth recovery. The surge in global commodity prices coupled with supply-side bottlenecks related to the pandemic have led to high inflation being more stubborn than was anticipated by central bankers across the world. The United States Fed is set to scale back asset purchases this year, and is expected to raise interest rates by mid-2022. This could lead to financial volatility across the globe, which may spill over to the real economy.

Finally, monetary policy has reached its limits, and the onus of sustaining growth will depend on the judicious use of fiscal policy space in the near term given that the net fiscal impulse is set to shrink beyond FY22 as the government cuts deficit along the consolidation roadmap to rebuild policy buffer.