Shape of recovery does not matter: Financial Express October 6 2020

 The same thought would prevail in FY22 as all numbers would tend to look better relative to the year before.

It has now been accepted that FY21 would be a washout from the point of view of the economy, which has been pushed back considerably due to the extended lockdown. The logical question to be posed is the possible shape of the recovery next year, and this is where the economists borrow the letters from the English alphabet and talk of a ‘U shaped’ or ‘V shaped’ or ‘W shaped’ path. The answer is that this would not really matter, and any emphasis being placed on the shape of the recovery serves little purpose.

There is always an optical view involved when interpreting numbers. Even in FY21, ever since the unlock process began the economic indicators have been showing an improvement on a month-on-month basis, albeit in the negative zone. The PMI looks better month over month as does the IIP growth number, even though the latter is still negative. Yet economists tend to interpret such movements as a recovery. Recovery probably not, but improvement certainly. The same thought would prevail in FY22 as all numbers would tend to look better relative to the year before.

Real GDP was valued at Rs 145 lakh crore in FY20 and will be down to a level of Rs 130-132 lakh crore this year. Hence even 10% growth in FY22 will take us back to the FY20 level, which is only a consolation. The aspiration of reaching a $5-trillion (nominal) GDP will still be a long distance away. Therefore, higher industrial growth, GDP growth, infrastructure growth, etc, could be expected. But what should we really be looking at in the next year to get solace that things have changed, considering that we are still not sure that the pandemic is behind us and it could just be that restrictions prevail in several sectors even in FY22?

The first parameter to be monitored is employment. It may be recollected that even before the pandemic came in there was constant debate on whether there was growth with limited job creation. This issue has been exacerbated during the lockdown with the exodus of migrant labour amongst the working class and large-scale layoffs in the organised sector, especially services, as business activity slowed down sharply. Even today, with restrictions on the number of people that can occupy office space as well patrons in the services sector, the scale of operations has been affected, thus impacting the demand for staff. Future growth will be driven by job creation, which, in turn, will guide demand.

The picture will be blurred to an extent by the substitution of labour with technology by several companies as the lockdown has forced businesses to change their way of work.

Second, the capacity utilisation rates in industry would need to witness improvement. The latest RBI data shows that it is at just about 70%. This number has been volatile in the region of 68-72% in the last few years and should show movement towards 76%-plus to give assurance that production is picking up. This will also indicate the prospects for future investment because as long as there is surplus capacity, there is less incentive to increase investment.

Production growth numbers would otherwise not be too significant and indicate just maintenance levels.
Third, corporate profit margins must show an improvement on a continuous basis and is a necessary condition that must be satisfied. Growth in sales and profits may be an optical fact as it would be based on low negative numbers in FY21. Therefore, there must be an improvement in profit margins for sure to reflect a turnaround in the fortunes of India Inc.

Fourth, and probably one of the most important traits to be monitored, is the level of ‘risk aversion’ of banks. At present, banks are reluctant to lend as the fear of NPAs building up is palpable. With growth falling to a negative number this year, it is but natural that the quality of assets would get affected. The moratorium and one-time restructuring exercise will cast a shadow on the true position, and banks will have to regain confidence that their portfolio is in good shape before they are able to lend in the normal course.

The classification of assets as NPAs has been blurred with the change in the definition of reckoning the same. But, at some point, there would be a return to normal, which would increase this ratio for certain. A conservative guess is that it could be in the region of 15% of total advances. Until this position is known, banks would be cherry-picking their lending, which, in turn, can affect the financing of investment.

Fifth, monetary policy should be returning to the conventional mode of taking decisions on just the repo rate and CRR along with development policies. It may be recollected that RBI has gone in for a series of liquidity-enhancing measures like LTRO and TLTROs to induce liquidity into the system. This will have to be unwound at some point of time; and to begin with, fresh issuances should stop, or else it would seem to be continuation of emergency measures to support the flailing economy. This may take more time as it has been witnessed in case of the Western central banks where unwinding of QE has been difficult and has now become part of conventional monetary policy.

Last, the fiscal state needs to show stability. While the fiscal deficit ratio can be targeted at a higher rate, it should be realistic in terms of growth projections that are made when estimating the revenue flows. This will be a major challenge as expenditures are fixed and will increase at a nominal rate. But the large slippages in revenue cannot be recouped in a year and the government must be realistic in its assumptions. With a lower nominal GDP base, which can, at best, be at the FY20 level for FY22, a lot of dexterity must be displayed in managing the fiscal numbers.

Therefore, the shape of recovery in FY22 will be an optical delight most probably but may mean nothing much but a statistic. FY21 will be the year where there was economic destruction caused by the lockdown, and FY22 will be an apology for a recovery and hence will be the second year lost. Quite clearly, we may have to look for real growth in the best possible case in FY23, assuming that a vaccine is found and administered on a large scale in the country. And we may have to begin with more modest numbers of 5-6% and then scale up towards the 7-8% mark over a couple of years.