India’s economic recovery appeared well on track until recently when the second wave of COVID-19 hit the country, posing a serious risk to early economic recovery.
The current and sharp rise in COVID-19 cases in India is proving to be an immediate threat to India’s FY22 growth prospects. The longer the second wave lasts, the more severe would be the adverse impact on the Indian economy. There will be a race between the pace of COVID-19 vaccination vis-à-vis. the speed at which COVID-19 and its new mutants spread.
Economic impact of COVID-19’s second wave
In the first week of April 2021, both the RBI and the IMF provided their latest assessments on India’s growth prospects for FY22. The RBI has pegged India’s real GDP growth at 10.5% whereas the IMF has revised its earlier forecast upwards, pegging India’s growth at 12.5%, which is 2% points higher than the RBI’s forecast. The RBI may be concerned relatively more with the adverse impact of the second COVID-19 wave sweeping almost the whole of India at present. These historically high real GDP growth rates mainly reflect a strong base effect following the contraction of (-) 8.0% in FY21. India’s projected growth of 12.5% in FY22 is noticeably higher than other major economies of the world, with China at the second position estimated to show a growth rate of 8.4%. These growth projections may come under severe challenge if the current second wave of COVID-19 is not brought under control quickly. Much would depend on the pace at which India’s population at large, gets vaccinated. In the meanwhile, indications are that the projected recovery in 1QFY22 may be curtailed due to the debilitating impact that COVID-19’s second wave is currently having on the Indian economy. Major economic and urban agglomerations are already reeling under its impact with partial and localized lockdowns with widening coverage by the day.
India’s multipronged economic challenges due to COVID-19
PMI manufacturing fell to a seven-month low of 55.4 in March 2021. PMI services also fell to 54.6 in March 2021, down from 55.3 in February 2021. IIP contracted by (-)3.6% in February 2021, its second successive contraction in the final quarter of FY21. Core IIP also contracted by (-) 4.6% in February 2021 as compared to a growth of 0.9% in January 2021. Reflecting supply-side constraints and the upsurge in the global crude and commodity prices, CPI inflation in March 2021 reached a level of 5.5% while WPI inflation shot up to a 96-month high of 7.4%. Indications are that the projected GDP growth by the RBI at 26.2% for 1QFY22, which is dependent on a strong base effect, would be challenged by the adverse impact of COVID-19’s second wave. Some estimates consider that this impact would shave off about 5-7% points from this projected growth. This may imply that the annual growth for FY22 may also have to be revised downwards by about 1% point. From a sectoral viewpoint, it is quite likely that the same sectors would suffer more in the second wave as those in the first wave. These include construction ((-)49.4%), trade, hotel, transport et. al. ((-)47.6%), manufacturing ((-)35.9%), mining and quarrying ((-)18.0%) and public administration, defence and other services ((-)9.7%). Figures in brackets indicate the contraction rates in 1QFY21. Because of strong base effects, there would be recoveries in all of these sectors, but the extent of recovery would be subdued. In minimizing the adverse impact, fiscal policy, which directly impacts the ‘public administration, defence and other services’ sector can play a crucial role. In order to keep up the level of overall demand, it may be advisable for the central and state governments to frontload their planned expenditure expansion particularly on the infrastructure sectors. At this stage, any increase in the already budgeted fiscal deficit at 6.8% of GDP for the central government in FY22, may not be called for. However, the situation may be monitored continuously and if private demand is seen to be faltering due to the impact of COVID-19, a more aggressive role for government intervention may become unavoidable.
Lessons from COVID-19’s first wave
We have a detailed In-Focus section on ‘Reflecting on the COVID-19 year: losses and lessons’. In this write-up, we have developed an Index of Relative Shock with a view to providing a comparative profile of different countries and within a country, different sectors and segments. We have argued that it may be relevant to measure the losses in the COVID-19 year not in absolute magnitudes but instead, in relative terms.
Our broad conclusions are summarized below:
- India, like all other countries, suffered an erosion of growth as a result of the impact of COVID-19 in FY21. When the extent of this erosion is viewed relative to a country’s long-term growth performance, India’s position does not appear to be as bad as revealed by a simple comparison of the magnitude of actual contraction in the GDP. In fact, India’s position is only the second lowest after China (Table 1).
- Looking at intra-sectoral impact on output growth in India, the worst performing sectors are indicated to be mining and quarrying, construction and trade, transport et.al.
- In terms of demand segments of GDP, apart from exports, the most vulnerable segments proved to be gross capital formation (investment) followed by private final consumption expenditure.
- In terms of policy interventions, in a comparison with major global economies, India’s fiscal and monetary interventions appear to be relatively less aggressive. India’s relative position was second weakest after Germany in the case of fiscal policy interventions (Table 2) and third lowest after Japan and China in the case of monetary policy interventions.
- Considering that the adverse impact of COVID-19’s second wave will mainly affect the economic performance in 1QFY22, it would be useful to frontload budgeted capital expenditures for FY22 in this quarter.
Some useful lessons may be drawn for India’s future economic strategy. First, a decentralized and diffused growth strategy where industrial activities are encouraged to settle away from major urbanized centres such as in smaller sized towns, peripheries of major urban centres and corridors connecting two or more major urban centres may provide a more robust development profile in coping with pandemic type challenges. Second, Atmanirbhar Bharat strategy appears to be well timed since in pandemic type situations, less dependence on global supply chains may be beneficial for minimizing economic damage. Third, expansion of capacity of providing health services as part of overall infrastructure expansion should be taken up on an urgent basis to improve India’s capacity to deal with COVID-19-type health shocks.
Are policy interventions needed at this stage?
Given the lessons from the first COVID-19 wave, and the challenges posed by the surging second COVID-19 wave, policy interventions may be considered from the immediate, the short, and the medium to long term perspectives. In 1Q and 2Q of FY22, the focus has to be on containing the health and the economic dimensions of the second COVID-19 wave. It may be recognized that the longer the second wave lasts, the more severe would be the adverse impact on the economy. There would be a race between the pace of COVID-19 vaccination vis-à-vis. the speed at which COVID-19 including its new mutants spread. In the immediate run, topmost priority should be given to investment in the health sector both for relieving the immediate shortages of vaccines as well as critical COVID-19-related medicines, medical oxygen, and pandemic-earmarked availability of hospital beds.
COVID-19 may be considered as a problem that is going to affect the Indian economy at least for the next three to five years. As such, policy intervention should be not only to ameliorate immediate shortages but also to create long-term capacity. Further, beyond the health sector, important economic sectors also require immediate attention. These include, as mentioned earlier, construction, manufacturing and some of the important service sectors. In these cases, private demand may experience a dip and demand may need to be kept up by fiscal and monetary policy stimuli. Here also, the scope for fiscal intervention may be more as monetary policy is likely to remain constrained because of the hardening inflation prospects.
In the context of deficient supply situation with regard to the COVID-19 vaccines as well as some of the important medical inputs including oxygen, a major issue in terms of their inter-state allocation and distribution seems to be developing. Since India has already in place, a framework for fiscal federalism, some useful lessons may be drawn from that experience.
India’s vaccination drive: is there a need for vaccine federalism?
As per the revised vaccination policy announced on 19 April 2021 (vaccination 3.0), universal vaccination above the age of 18 years is to be allowed from 1 May 2021. In addition to the central government, state governments and private players have also been allowed to directly access the vaccines from the domestic or foreign suppliers and then according to their own policy, vaccination may be implemented in the respective state. Private firms have also been allowed the same facility. Domestic suppliers will have to pre-announce their prices before 1 May 2021.
Prices for imported vaccines may have to be individually negotiated. These changes will be implemented along with the central government pre-empting 50% of the domestic supply, which will be distributed to the population above 45 years of age as per the existing policy in the government hospitals. Thus, the supply situation may improve with better financial returns for the domestic suppliers and more investment can also take place. There is a lot of ambiguity in relation to the prices that may prevail. With a fragmentation of the market, the possibility of black marketing may also increase. For the 50% of the central distribution across states, the issue of inter-state distribution would still remain and will call for an objective and transparent formula-based distribution mechanism.
The current mechanism of inter-state allocation of the COVID-19 vaccines in India is characterized by non-transparency and ad-hocism. We have ascertained in an econometric exercise that the two main determinants of the inter-state variation in the incidence of COVID-19 in India as measured by the number of COVID-19 cases as a percentage of state population are: (1) share of non-young population in the total population of the state and (2) share of the state in the total population undertaking international travel. This exercise related to India’s 18 medium and large states.
Factors affecting COVID-19 incidence may be divided into two categories, those under the control of the state governments and those that are beyond their control. In the vaccine allocation process, states that are deficient in their COVID-19-containing effort should not be rewarded in the allocation mechanism. Instead, the mechanism can be set in a manner such that states can be incentivised to improve their effort. It may be useful to appoint a high-powered committee to suggest a formula-based transparent mechanism for the inter-state allocation of vaccines just like what the Finance Commission does for the sharing of central taxes.
In the US, the ‘Tiberius algorithm’ has been used for allocating vaccines to the subnational governments wherein the vaccine allocation to a jurisdiction is determined based on its census-derived percentage of population over the age of 18. In India, a recent study by IDFC Institute has quantified an inter-state COVID-19 preparedness index which may also be a relevant factor in the allocation exercise for vaccines particularly when more imported vaccines may be used where facilities for cold storage and transportation may be relevant.
In the medium to long run, as the vaccination process becomes progressively universalized, there may be a need for the private sector and the market forces to play a more active role in the supply and distribution of COVID-19-related vaccines, medicines, and other support services. In order to protect the interest of the low income group, a regulated mechanism of inter-state allocation of vaccine at subsidized prices may need to be continued in the medium-term even as the private sector and market forces are allowed to play a greater role in the procurement and distribution of vaccine supplies.
While the attention of India’s policymakers at the moment is focused on dealing with COVID-19 in general, and its second wave in particular, it would be useful to keep the medium to long term economic prospects and potential of India as the centre piece of economic policy. In the post-COVID-19 economic universe, most inter-country relationships are likely to undergo major changes. India has to find its rightful position in the new world economic order. The Atmanirbhar strategy has been well-conceived and is quite timely. All efforts should be made to attract investment into India so that India can play a major role in the global supply chains. India will have to compete with China, US, and the EU for attracting investment. In this context, India’s CIT reforms making the CIT rate competitive will become quite relevant. We may also recognize that recently, the US has announced a major stimulus program which includes a long-term plan intended to last until the end of the decade primarily for infrastructure expansion and clean energy worth US$2 trillion which may be financed partially by an increase in the US corporate tax rate from 21% to 28%. If India continues with its current CIT regime, this may have major implications for incentivizing relocation of US investment towards India.
India has embarked upon its own infrastructure expansion plan in the form of the National Infrastructure Pipeline (NIP), investment in which will continue until FY26. In India’s plan, both the central and state governments including their public sector enterprises and the private sector are to participate. If required, for financing the NIP, the central government may keep its fiscal deficit well above the current FRBM norm of 3% of GDP up to FY26. According to the RBI, the combined fiscal deficit of central and state governments is projected at 10.8% for FY22. Indications are that the central government may improve upon its tax collections in FY21 as compared to the revised estimate. Given the improved revenue performance prospects, the central government may do well to frontload its budgeted FY22 capital expenditure in 1QFY22 so as to partially mitigate the adverse economic impact of COVID-19’s second wave.