OECD Economic Outlook, Volume 2020 Issue 1

India

The single hit scenario assumes that the 10-week general lockdown, followed by some targeted lockdowns, succeeds in avoiding an acute health crisis. In the double-hit scenario, a renewed virus outbreak will require a new general shutdown in the autumn. New restrictions on internal migration and disruptions in supply chains would have severe consequences on activity and income while external demand would falter again. In this case, GDP is projected to fall by 7.3% in FY 2020-21, compared to 3.7% in the single-hit scenario. The poor, informal workers and small enterprises will suffer disproportionately; weak bank and corporate portfolio positions will keep the investment rate low, weighing on growth prospects. Inflation remains under control given economic slack and low oil prices. Public deficit will spike, reflecting faltering tax receipts and needed spending to support people, banks and small enterprises.

Protecting human lives is the immediate priority and requires additional health care resources and generous support to the poor. Getting activity back and avoiding a durable effect from the crisis on income and jobs require promoting access to credit. Bank recapitalisations and governance reforms should accompany government-backed guarantee schemes. An inclusive growth strategy over the longer run should include prioritising social investment and income support for the poor, which can be financed by reducing energy and fertiliser subsidies and the tax expenditures that most benefit the rich, and modernising labour and business regulations to promote quality job creation and extend the social safety net.

Despite early and strict containment measures, the virus is affecting many

The virus manifested itself from late January. Infections have been concentrated in large cities, in particular slums, with a risk of a fast spread given India’s high population density, poor housing conditions in some areas and large internal migration flows. The number of new cases was still rising as of early June. High air pollution adds to the severity of cases while the population age structure – almost half of Indians are below the age of 25 – has the opposite impact. Human costs from the disease have been compounded by a shortage of healthcare resources, in particular hospital beds, doctors, and testing facilities.

India: Health care and unemployment

1. 2018 or latest available year. Data for India refer to 2017.

Source: OECD/WHO Health at a Glance: Asia/Pacific 2018; OECD Health database; Centre for Monitoring Indian Economy (CMIE).

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India: Demand, output and prices (double-hit scenario)

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India: Bank loans and two scenarios of real GDP

Source: Reserve Bank of India; and OECD Economic Outlook 107 database.

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India: Demand, output and prices (single-hit scenario)

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To contain the virus from spreading, the government reacted swiftly by introducing border measures and quarantines in mid-March despite a still low number of identified cases. It took measures to free up healthcare resources for those affected by the virus, including the deferment of elective surgeries and temporary export restrictions on medical goods, and ramped up testing capacities. It introduced a mobile app (Aarogya Setu), to help people identify their risk of contracting COVID-19 through tracking and contact tracing, and to connect people to healthcare services. Some states have built on their experience with other viruses and used extensive testing, contact tracing and community mobilisation. The strict lockdown implemented on 25 March, including the suspension of all domestic public transport, has helped to flatten the infection curve. It has been relaxed in a phased manner since 20 April, starting with rural and agricultural activities, export and special economic zones and in COVID-19-free districts. However, strict confinement measures have been maintained in areas where the number of cases is high or rising (so‑called containment zones).

The COVID-19 crisis is affecting the poor and small enterprises the most

The lockdown has taken a heavy toll on the economy, with up to two-thirds of activity either shut down or working at reduced pace during the first four weeks and more than a fourth in the following four weeks according to various estimates. The mobility of individuals has fallen steeply in Delhi and Mumbai, though less so in rural areas. Trade, transport and construction have been badly hit. The unemployment rate has surged. Urban workers with no formal job contract and daily labourers have suffered the most. Millions of domestic migrants have struggled to go back to their villages and families. Agricultural activities have faced labour shortages during a peak, harvesting, season. The purchasing manager index for both manufacturing and services contracted sharply in both April and May, reflecting business closures and falling demand. The lockdown is disproportionately affecting small enterprises with limited cash‑flow, with knock‑on effects on supply and distribution chains. This adds to the financial woes that India was experiencing before the COVID‑19 crisis from overly leveraged corporates, high non‑performing loans and recurrent liquidity and solvency problems for some banks and other financial institutions. The spike in corporate yields and subdued lending activity suggest that risk aversion is high.

The authorities have announced a wide set of support measures and structural reforms

A 10%-of-GDP support package has been introduced, including fiscal and monetary support, as well as guarantee schemes. The Reserve Bank of India has acted swiftly to reduce the cost of capital and avoid the liquidity shortfall induced by the lockdown becoming a solvency crisis, with permanent economic and social costs. It cut policy rates, injected liquidity (about 4% of GDP), including through long‑term repo operations, and softened prudential norms. The impact on the real economy is, however, somewhat muted by banks and corporates’ balance sheet problems and acute risk aversion.

The government introduced two sets of fiscal support measures. The first package, introduced late March, embodied a health emergency component and support for most vulnerable groups, including one‑off cash transfers to more than 200 million rural women with basic bank accounts and 30 million old‑age and disabled people, in‑kind support (mainly food) for about two-thirds of the population and a medical insurance cover for health professionals. The second package announced mid-May enhanced in-kind and cash support, targeting in particular millions of internal migrants without ration cards, and extended the rural workfare scheme. It also contained several measures to reduce financial stress and ease access to funding for various entities, including non-bank financial corporations, micro, small and medium enterprises, farmers, street vendors, the power sector and real estate companies. The government further announced several structural reforms to encourage investment, including partial deregulation of the agricultural sector, lower entry restrictions in eight industrial sectors and a revised definition of micro, small and medium-sized enterprises, which reduces incentives to stay small.

Activity will recover only slowly, leaving many vulnerable people and companies worse off

The single‑hit scenario assumes that the strict national lockdown (25 March - 19 April) followed by a very gradual opening in the following six weeks (20 April – 31 May) and targeted lockdowns in June succeed in controlling the infection rate. In the double‑hit scenario, new containment measures and strict social distancing measures have to be re-introduced in the last quarter of 2020 and the economy also suffers from lower external demand as a second wave of infections hits its trade partners.

The economy will recover as lockdown measures are eased, but will suffer from scares. Pent‑up demand from postponed consumption and inventory restocking will boost activity. Lower oil prices will be a boon for households and companies, inflation, the budget and the current account deficit. However, domestic demand will suffer from the permanent loss of income in many enterprises and the informal workers who lost their jobs. Uncertainty over the return of working migrants, the difficulty for small enterprises to finance their working capital, and business closures will disrupt supply chains. Subdued quality job creation will heighten poverty. Stress on the balance sheets of the government, banks and corporates will make it difficult for the investment rate to recover promptly, holding back future growth prospects. Adverse impacts of the crisis will be more severe in the double-hit scenario, with investment falling by 22% in FY 2020-21 and income remaining below pre-crisis level up to the third quarter of FY 2021-22. In the more benign scenario, the decline in investment and consumption is less pronounced and income reverts back to the pre‑crisis level in the last quarter of 2020. The fiscal deficit will rise, reflecting collapsing tax revenue, the need to bail out financial institutions and firms, and lower-than-budgeted privatisation proceeds.

Heightened financial market instability, resulting from the deterioration in balance sheets of the government, corporates and banks, is a key risk. Public debt, non-performing loans and corporate leverage were all high before the COVID-19 crisis. The threat of sovereign and corporate rating downgrades would affect private investment and the government budget. On the other hand, external vulnerability is lower than in many other EMEs, given a relatively low external debt-to-GDP ratio and large foreign exchange reserves. History reveals that India tends to undertake structural reforms best during severe crises; new measures could be announced to unlock the growth potential and job creation, on top of those announced in May for the agricultural and industrial sectors.

Policies should address urgent and longer-term priorities

The first priority is to mitigate the human and sanitary crisis by ramping up health care resources (in particular testing kits, isolation facilities and drugs) and by providing sufficient cash and in‑kind support to all those in dire need. Adjusting support programmes to needs, as the sanitary situation develops, will be key. The second priority is to reboot economic activity and job creation. Newly created government‑backed guarantee schemes to ease enterprises’ access to loans should be accompanied by a bold programme to reform and recapitalise public sector banks. This, together with an adjustment in administered interest rates, would help improve monetary policy transmission. In the longer run, the authorities will need to be more selective in supporting companies and banks. Faster bankruptcy resolution procedures will avoid locking resources in zombie firms. Incentives for the states to implement structural reforms, in particular in the agricultural sector placed under their responsibility, could be promoted beyond the recent conditional increase in their borrowing limit from 3% to 5% of state GDP, e.g. through the vertical grant system. Modernising labour laws would bring more workers into the formal sector and extend the social safety net. India could also progress further in moving from price subsidies to direct/digitised income transfers, an area where India has progressed rapidly. Reducing subsidies on fertilisers, water and energy consumption would reduce pressures on environmental resources and create fiscal space to improve social infrastructure, including education and health, and income support for the poor and rural workers.