H1 2020 Economic Review

The global economy is witnessing its worst economic collapse since the great depression of 1930. Unlike the 2008-09 meltdown, this time the Indian economy is no exception to the global trend and is witnessing the worst ever slowdown in the history of the post independence period. In the past 40yrs, since FY80, when Indian economy declined by 5.2%, we have not seen any year of negative growth.

Economic growth collapses, long term growth curve shift downward

The economic growth in India has been declining structurally since the global financial crisis (GFC) of 2008-09. For a couple of years, monetary and fiscal stimulus given by the extant government to mitigate the impact of the global crisis supported the growth. However, post FY13, the growth trajectory never looked like retracing to pre GFC levels. The down trend just got accelerated by the COVID-19 induced lockdown of economic activity. In FY21 India is widely expected to record its worst ever recession with a negative growth rate of -6% or worse. The more worrisome part is that the long term growth curve in India has shifted down. The potential growth in India is no longer 8% plus. The pivot is somewhere close to 6%. A strong number in FY22 would be purely a base effect.

The worst part is the collapse of nominal GDP growth to multi decade low level. Even the nominal growth is likely to witness a sharp correction in FY21.

The government's budget, revenue and expenditure targets, sectoral allocations, and all allocation for all social and development programs is usually based on the nominal growth numbers. The benign inflation post GFC has resulted in a faster decline in nominal GDP growth as compared to the real GDP growth. However, now the nominal growth has reached the level where a decline would directly result in lower wages, lower rental and lower returns on savings.

A sustained downward trend in nominal growth may result in some dramatic adjustments in socio-economic structure. The effective rate of taxation may have to be raised considerably to meet the social development targets. The household savings that have been a traditional source of safe and steady funding for both corporate and government may decline widening the gap for fiscal and corporate funding. The socio-economic inequalities may rise materially as the poor and middle classes become sustenance households (earning just to meet the expenses, just like developed economies) without any material social security benefit.

(a) Infrastructure investment had been on the decline since FY13. The lockdown has accelerated the decline further. The private sector investment in infrastructure building has declined materially.

(b) Domestic demand has collapsed to worse since GFC at least. GVA (ex Agri and Govt Expenditure) has declined much faster.

(c) Capacity utilization is the worst in decades, though it has seen some marginal improvement in June.

External vulnerability though less pronounced this time

Despite the severe economic down trend and sovereign rating downgrade, the external vulnerability of India has been significantly less pronounced as compared to previous episodes of downtrend.

(a) The trade balance has shown significant improvement.

(b) INR has been very resilient despite the FPI selling and rising outward remittances.

Fiscal condition worsens materially, monetary easing accelerates

The fiscal gap for FY20 increased to 4.6% of GDP, the worse since FY13. The gross issuance by state and center is expected to top Rs20trn, almost 50% higher than FY20. However, ample liquidity and sharp easing by RBI has ensured that rates continue to remain benign and funding of fiscal gap does not become much of a problem.

In the past five years, since July 2015, RBI has halved its benchmark repo rate 8% to 4%, the lowest level seen in decades. Despite this we have not seen any signs of acceleration in economic growth. The credit growth has remained low and is expected to plunge to zero by end of this year; as the supply of money (deposits) continue to outpace the demand (credit)

Wholesale prices enter negative territory in May 2020

The wholesale price index (WPI) based inflation in the month of May 2020 slipped into deflation for the first time in nearly 4 years. (Important to note that WPI for May, 2020 has been compiled at a response rate of 75% and will undergo a revision). WPI cooled off mainly due to broad based deflation seen in all segments viz; primary articles, fuel and power and manufactured products. The rate of inflation based on WPI Food Index decreased from 5.2% in March, 2020 to 2.3% in May, 2020, the lowest in the past 16 months.

First synchronized global recession since 1930

The global economy is expected to shrink more than 5% this year, in the most synchronized slowdown since the great depression of the 1930s. The global trade has collapsed; delinquencies are rising and the central banks are doing whatever it takes to prevent markets from freezing, learning a lesson from the 2008-09 global financial crisis.

To sum up, the economic realty looks ugly and the chances of any V shaped recovery appear remote. Especially in the case of India, the economic slowdown that started many years ago may end in the next few quarters, but the recovery will be feeble and Indian economy may not attain a sustainable 8%+ growth potential for many years.