C + I + G + (XM) —Where will India’s post-pandemic growth come from?
C + I + G + (XM) —This ubiquitous equation adds up the country’s GDP.
As the Indian economy emerges from the Covid crisis, the question is which component of this equation will contribute the most to GDP growth? Will it be C or consumption? Will it be me or a private investment? Will G, or the government, have to do the heavy lifting? Or can (XM) or net exports give the economy the much-needed boost?
JPMorgan Chief Economist for India Sajjid Chinoy believes that two of these elements, public investment and exports, could support the economy’s growth over the next six to eight quarters while waiting for the consumption strengthens and private investment picks up.
Private consumption, driven by leverage in recent years, has maintained the Indian economy in the absence of private investment.
Will the losses of jobs and income induced by the Covid crisis weaken consumption? Or will the richest 10-20% of consumers who have gotten away with it and seen asset values rise in value, are they going to increase their spending?
Chinoy is cautious about how quickly consumption will return. It highlights the fact that disposable income to GDP, between 2012 and 2019, decreased by two percentage points, and consumption to GDP during this period increased by four percentage points. This, because consumption was financed by households which reduced their savings and got into debt, he explained.
But this growth in consumption had started to slow well before the pandemic and even before the NBFC crisis of 2018.
As in many other parts of the world, India has also seen a K-shaped recovery.
It is, according to Chinoy, a transfer of income from the bottom up. “For every dollar that goes from the bottom to the top, the marginal propensity to consume is actually lower at the top than at the bottom,” he explains. “So in the steady state one should expect consumption to decrease, not increase.”
GDP data for the period September 2020-March 2021, when the economy started to recover, corroborates this analysis. “Of all the consumption drivers of demand, investment, government spending, exports, consumption has been the slowest and weakest to return to pre-pandemic levels,” Chinoy said.
Growing household debt and mixed expectations of future income could combine and imply more cautious consumption.
While consumption growth remains moderate, private investment will also remain moderate.
While the double balance sheet problem – high indebtedness of under-capitalized companies and banks – has eased, the new constraint on private investment will be weak demand. Capacity utilization has remained below 70% and until demand increases significantly to drive it up, new investment will remain slow, Chinoy said.
He also warned that while large companies have seen their balance sheets strengthen, small businesses may not have. This could have an impact on the investment capacity of this segment of the economy.
If consumption and private investment do not stimulate growth, what will?
Chinoy thinks it will be public investment and exports. Strong global growth, he said, could help keep exports buoyant. Merchandise exports are nearly 20% above pre-pandemic levels. Even after adjusting for the price effect of higher prices, manufacturing exports are growing in double digits.
Underlying the expectation of favorable winds in export growth is the belief that years of “secular stagnation” globally will give way to a new normal. This new normal could lead to growth in developed markets of around 5% over the next two years. “That, other things being equal, should provide a significant tailwind for Indian exports and we are already seeing it.”
Public investment will be the other support for growth.
The central and state governments have forecast a 30-35% growth in capital spending this year. Data available for the April-June period suggests that at least the central government has kept pace with spending.
The need to focus on growth, said Chinoy, has never been greater. “For job creation, income improvement and debt sustainability, potential growth and (the need to ensure) medium-term growth have never been more urgent.”
In this context, it is important to assess India’s growth potential. It is also important to understand this in light of core inflation which has remained high even as demand has fallen sharply.
“Does this tell us anything about the offer that we need to consider in the future?” We have seen this K-shaped recovery where large companies have increased their market share. Does this translate into higher pricing power? Has the impact on SMEs, and therefore competition on the supply side, been greater than we think? These are all telltale signs that a new examination of potential output is going to be very crucial in the future, ”Chinoy said.
In assessing potential growth, Chinoy focuses on total factor productivity or, more broadly, the productivity of the economy. “If you look at India’s growth in 2005-2006, TFP contributed five percentage points to potential output in 2005-2006,” he said. “That in our calculations, this is all pre-pandemic, it has come down to two and a half percentage points.”
Public investment, trade openness and a strong financial sector are generally determinants of productivity. Each of them, according to Chinoy, will require special attention in the post-pandemic period.
“If you can stimulate productivity growth, wages will rise, when wages rise and incomes rise, it creates the conditions for more sustainable consumption.”