India to enjoy a strong cyclical rebound in 2021 but with structural challenges

India’s economy fell sharply by -9.3% in the first three quarters of 2020 due to a preemptive strict lockdown in Q2 2020 to contain Covid-19. Excessive dependency on services, sharp supply constraints and limited manufacturing exports did not provide respite. In addition, a rather cautious fiscal stimulus did not help avoid the worst, in growth terms. That said, the silver lining of plummeting growth is the massive favorable base effect, which will help India grow fast in 2021 by 8.7%.

Decline of demand, and thus imports as well as monetary easing through rate cuts, quantitative easing and regulatory support, have helped turn the current account into surplus and eased financial conditions substantially. Additionally, the government change of strategy on Covid-19 by avoiding costly lockdown even as the virus spiked in Q3 2020 also helped with the recovery. Moreover, cases have declined steadily since then, which have sharply improved mobility and thus growth. This is already clearly seen in data such as the PMIs and imports, both expanding rapidly and amongst the best in Asia.

The budget unveiled on 1 February for fiscal year 2022 (Q221 to Q122) showed the government will continue to support the recovery through sharp increases for capital expenditure of 26% while refraining from raising taxation. The focus to increase infrastructure spending and ease import duties for infrastructure intensive commodity such as steel shows a strong commitment to target higher quality spending. Beyond capital expenditure, health took priority with INR2.2trn spending, which should pay off as India is ahead of emerging markets in vaccine acquisition and distribution. While estimated borrowing declined on a %YoY basis, it was still higher than pre-Covid at INR12trn.

Beyond the sharp cyclical rebound, concerns regarding India’s medium-term prospect remain. First, the recovery in employment is uneven, which points to the lack of structural growth engines, particularly on the manufacturing sector, which is very much needed to absorb India’s woefully underemployed labor force. Second, while system wide liquidity improved, credit growth is sluggish and remains constrained due to an undercapitalized banking sector with rising NPL that is masked by regulatory support. Finally, while India still lacks the ambition to expand outward and attract manufacturing FDI, as it has not negotiated any major trade deals in juxtaposition to China’s RCEP – from which India did not partake – and one with the European Union.

That said, India is showing some marginal positive change in this budget to chip away at structural issues, such as liberalizing the insurance sector to FDI to 74% from 49%, as well as creating a fund to deal with bad debt and INR200bn to recapitalizing state banks. Reducing import tariffs, especially for key inputs for much-needed infrastructure, is also helpful. Recent labor market reforms as well should help. Still, much more is needed for the multitude of challenges.

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