View: Why ​India’s illusory V-shaped rebound shouldn’t prompt premature fiscal conservatism


India’s real GDP growth — projected by the NSO at 9.2% during 2021-22, and consensus expectation of 7.6% in 2022-23 — is seen to represent a V-shaped rebound from the deep 7.3% contraction in 2020-21. Many also believe, as has been hypothesised several times in the past 6-7 years, that India is currently standing at the cusp of a multi-year expansion cycle. What is also motivating the cyclical inflection viewpoint is the fact that large indebted companies have deleveraged their balance sheets, aided by improved cash flows from the post-pandemic gain in market share from smaller players, and the skewed impact of rising global commodity prices for metal companies. The expectation is that this episodic outpouring will stimulate fresh investments by the private sector after a hiatus of over a decade.

But considering the past, from the time when India’s economy was classified as the “fragile five” in 2013 to being labelled as the fastest growing economy and yet seeing the ever-expanding joblessness and rising impoverishment, the irony has never been so stark. Contrasting the significant improvement in the financial matrix of large corporates, the balance sheets of households, government, and small/informal businesses have worsened considerably. The combined fiscal deficit of states and central governments has spiked to an average of 12% in the aftermath of the pandemic, and government debt/GDP has risen to an 18-year high of 92%. Ironically, however, the pace of government consumption spending, which accounts for 85-87% of its total spending, was lower by 5.3% in real terms during the first half of 2021-22 compared to the corresponding period two years back (2019-20); it followed a modest 3% annual growth during the lockdown year 2020-21. And the accounts of the central government show that revenue spending, excluding interest payment has been growing modestly at 6% YoY during Apr-Nov 2021 or -1.5% YoY in real terms.

Thus, not only is the expansion in fiscal deficit and public debt attributable to rising interest burden (35% YoY), shortfalls in non-tax collections (including disinvestments), and inadequate buoyancy in tax collections, the government’s contribution in resurrecting the demand shock has been negligible when private spending is still substantially weak. The post-COVID stimulus was largely in the form of liquidity support with little actual spending even as the steep hike in fuel taxes and higher dependence on indirect taxes impacted the spending power of households. Simultaneously, cuts in corporate taxes from 30% to 21% in 2019-20, which was again a supply-side stimulus, helped improve corporate profitability.

Higher capital allocation (28% YoY and 13% in real terms), largely on government construction, defense and railways will create longer-term productive capabilities but may not have a significant immediate demand multiplier impact. Hence, the conventional crowding-in effect of government spending to encourage household demand during economic shock has been inconsiderable.

The latest compilation in the “Inequality Kills” document presented by Oxfam at the World Economic Forum in Jan 2022 highlights that as per the Forbes Billionaires report, in October 2021, the collective wealth of India’s 100 richest hit a record high of USD 775 billion despite the pandemic. Simultaneously, however, as per the CMIE survey, 84% of households experienced a decline in income.

It is not just the pandemic alone. The fragility of the household sector had been building up earlier as concerns on income and employment were palpable even in 2012-13 and reflected in the rise in the unemployment rate to a 45-year high of 6.1% in 2017-18 as per the NSSO data.

Data from CMIE shows that the unemployment rate has been rising steadily from 3-4% in 2017 to the current 7-8%. But the more concerning aspect is that the fall in the labour participation rate (LPR, proportion of working age population seeking employment) to 40% in 2021 from 46% in 2016 is accompanied by a fall in the proportion of households with greater than one employed person to 24% from 35% during the period (28.4% in 2019).

Thus, in an environment of unemployment rate scaling new historical highs, the fall in LPR indicates a rising proportion of discouraged labour withdrawing from the labour market. Hence, the effective unemployment rate may be much higher.

The weakening employment scenario is also reflected in the rising share of people who consider themselves self-employed, classified as clusters of unorganised and small business engagements outside of regular businessmen and professional entrepreneurs. As a proportion of total entrepreneurs, it is estimated to have increased to 79.6% in 2021 from 73.3% in 2019 and 62.4% in 2016 (CMIE), which corresponds to the decline in employment. These indicate the presence of underemployment and disguised unemployment.

The weak employment scenario pervades multiple sectors despite the strong traction in areas such as defense, fertilisers, couriers, semiconductors, IT, and office equipment (as per Naukri Jobspeak Index) which are collectively up 5.6% from the pre-COVID levels. A big chunk of the remaining other labour-intensive sectors is 25% lower.

Average monthly employment during Sep-Dec’21 shows a significant decline from pre-COVID levels in industrial employment (11mn or 25% decline, CMIE data) and employment in services (5mn or -3.2%). This displacement of labour has been accommodated in agriculture sectors (up by 10.8mn or +7.3%) and construction (up by 4 mn or +6.9%). Thus, there has been a labour migration to low productivity-low wage employment, expanding disguised employment in agri sectors, and excess supply of labour at the broader economy level.

Growth in both rural and urban wages net of retail inflation is averaging close to zero for the past few years and got accentuated due to the COVID-19 shock. Slackness in employment has also impacted the consumption demand situation highlighted by a structural decline in the production of automotive (two-wheelers, cars) and most discretionary items.

Thus, notwithstanding the episodic improvement in corporate balance sheets, the past seven years have seen positive circularity between growth in sales, compensation, consumption, and capacity expansion diminishing. The average net sales growth of Indian companies has declined to 4.9% (on a trend basis) from 16.5% 10 years back while average volatility has risen substantially. The heightened volatility, caused by multiple factors such as global trade protectionism, the demonetisation shock, GST-related dislocation, NBFC crisis, and COVID shock, along with growth deceleration has impacted hiring and investing activities even in the organised manufacturing sector that has gained market share from the unorganised sector during multiple episodes of shocks.

With the manufacturing sector still employing 25% less labour compared to pre-COVID, an optimal scaling-up of labour to the existing capital mix will need to emerge before further capacity addition. Indeed, while there has been strong performance in select capital goods led by government spending on railways and road construction, nearly 70% of the components are still significantly lower than 4 years back. It is not surprising, therefore, that the traction in new projects announced by private corporates continues to languish.

An optimistic scenario would be the re-emergence of the positive confluence of improved urban labor compensation, and leveraged spending. The lagged impact of the revival of sales growth may induce gradual improvement in job creation in manufacturing and services, thereby mitigating the prevailing conditions of labour market slack, weak wage growth, and low productivity. But a realistic scenario of still modest corporate sales growth (8-quarter average is still just 6%) may still see muted revival in compensation and wage growth leading to default risk on retail loans.

Hence, attempts to fit in a V-shaped rebound theme for India appear illusory. The post-COVID global scenario will likely feature lower average real GDP growth of 2.4% during 2020-23 compared to 3.3% in the prior period of 2013-19 (OECD estimates), with a larger loss of growth for emerging market economies like India due to the deeper impact of the pandemic (3.7% vs. 6.8%) and China (5.1% vs 6.8%). On a divergent growth path, advanced economies (AEs) including the US and Europe are likely to experience a lesser decline (1.7% vs 2.2%) even as the world experiences higher inflation (3.1% vs 1.7%), emanating from the disproportionately large stimulus in AEs resulting in tight labour markets, the quick decline in the unemployment rate to historical lows, and persistent supply bottlenecks. Elevated public debt in most economies may also accentuate the trend towards trade protectionism as countries adopt domicile bias as tax incidence rise.

The expected normalisation of the excessively easy monetary policies in AEs, especially in the US which is experiencing record-high inflation, and moderating global trade openness will likely make India policies tricky if financial conditions tighten leading to higher interest rates, sharp currency depreciation, and narrowing external capital flows. Fears of a rating downgrade amid the doubling of fiscal deficit, historically high public debt/GDP, and quick re-emergence of the current account deficit may increase the chance of premature fiscal conservatism. This may prove counter-productive if the private sector fails to recover adequately.

The persistent fragility of Indian households, amid rising wealth and income inequality, will require prolonged fiscal support. But given the limited fiscal bandwidth, a constructive strategy of shifting to a more progressive tax structure, featuring lower dependence on indirect taxes and higher direct taxes on the wealthy may be appropriate.

The aggressive 33% and 35% step-up in food distribution scheme and MNREGA employment respectively during the pandemic years of 2020-21 helped protect the low-income brackets, but the rise in poverty level from 64% to 72% in urban areas and 83% to 88% in rural areas (measured against 7th Pay Commission minimum wage of Rs 4,660 per month, Arpit Gupta, et al, NBER paper Dec’2021) makes it pertinent to implement some kind of transfer scheme to compensate for income loss, medical and educational needs.

Evidence from both the US and India in recent times shows that corporate tax cuts did not serve well in resuscitating private capex, particularly in the US where corporate profit to GDP has risen to an all-time high of 14.5%. In the Indian context, where the degree of uncertainty is much higher, it will be relevant to sustain a demand-supportive fiscal strategy.

The lapse of compensation cess for state GST in Jun’2022 and concerns of revenue shortfall may also compel fiscal tightening by state governments, which may be undesirable given the rising share of development spending. Hence, necessary flexibility on fiscal management may also be required for states.


Source: The Economic Times
(This is an auto-generated article from syndicated news feed. TEAM BEPINKU.COM may not have modified or edited the article).

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