Anticipating the Unintended #66: An Alphabet Soup of Economic Recoveries

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

India Policy Watch #1: Scarring Effects Of The Pandemic On Indian Economy

Insights on burning policy issues in India

— Raghu Sanjaylal Jaitley and Pranay Kotasthane

What kind of recovery will we have? We have an alphabet soup of opinions. The latest entrant is the K-shaped recovery. It isn’t as strange as it sounds. The argument here is most industries will have a few companies that will benefit from the pandemic in gaining market share and consolidating industry profits with them. So, their graph will rise. While the rest will struggle with debt, lower profits, and an inability to invest. This divergence (‘K’) will be a feature of most industries.

Who knows, really? We are nowhere close to the COVID-19 peak in India. We have no choice but to open up despite the test positivity rates that are high in many states. The consumers aren’t flocking to the malls and shops to spend. Most companies are in a wait and watch mode on capital investments. Any predictions on the shape of our recovery at this moment is a mere shot in the dark.

The officials of the finance ministry and the chief economic advisor (CEA) are confident we are beginning to see a V-shaped recovery. The high-frequency economic indicators are showing an upward movement and there is a belief this trend will sustain.

The Shape Is Irrelevant

We think these discussions don’t offer any insights. Why?

Well, any recovery will be V-shaped once you know the bottom has been reached. Since we know there is no possibility of another full lockdown, we will never see those lows on the graph again. This is simple. So, any curve that has fallen sharply and then begins to rise will look like a ‘V’. The other thing to consider here is the basic unit of time that is used to compare data. The smaller the unit of time, the more the curve resembles a ‘V’. So, if we observe monthly data since June when the unlock started in a meaningful way, we will see a ‘V’ shape emerging. But if we consider quarterly or half-yearly data, the ‘V’ will take time to emerge. So, we expect monthly charts to be in vogue for some time. Lastly, there is also a variable of the length of time you monitor this data. If you show it for six straight months, you can establish a ‘V’ shaped recovery is on and then stop.

We believe there are three questions to ask about the recovery in India:

  1. How sharp is the recovery? Is the ‘V’ narrow or wide?
  2. How long will it take for the economy to recover to its pre-Covid levels?
  3. Will there be some kind of hysteresis or ‘permanent loss’ of economic activity because of the pandemic which will have long-term economic impact? How do we quantify it and, possibly, mitigate it?

Understanding Recovery

Let’s examine these.

In our view, the ‘V’ will be wide. We can’t have a sharp recovery unless the national daily case count falls below a thousand. That looks some time away. And even if we reach there it will take more time after that for confidence to return for economic activities to resume like before. So, if we take a unit of time that’s longer than a month and observe economic parameters for longer than a year, we will find a wide ‘V’ indicating a dull recovery.

The pre-Covid levels will be attained at different times by various sectors. It is clear that travel, hospitality and entertainment will take much longer to go back to their previous levels. Other sectors like real estate, banking and automobile will lag till there’s buoyancy in the job market with real wage growth. Sectors like food, e-commerce, agriculture, IT services will recover the fastest based on evidence during the pandemic so far.

Two points need to be emphasised here. One, there has been a huge impact on the informal economy in every sector. The shift of consumption to the formal economy has accelerated during the pandemic. E-commerce growth is a good example of it. Any growth data emerging from the formal economy must be viewed in this context. Two, the availability of the vaccine and its delivery will be a critical factor in this. Assuming we have most of India vaccinated by the end of 2021, we should see normalcy in 2022.

Considering the above, we shouldn’t fall into the trap of looking at select sectoral data or formal economy trends to figure if we have recovered to pre-Covid levels. We will need to view this at an aggregate level. Even that might be only part of the picture considering how large a part informal economy plays in India. We have suggested earlier we expect 8-10 per cent contraction in GDP in FY 21 (year ending March 2021). A 4-5 per cent growth in the next two years thereafter will mean we return to FY 2020 (ending March 2020) levels only by March 2023. This is a reasonable estimate and our view is it might not be any different for most economies in the world. Our high case count right now might delay us by about six months.

Pictures speak a thousand words. So here are a few projections at how the wide ‘V’s might look like. The key point here is that growth rates can no longer be the only number to look at now. That’s because given that there is a discontinuity in the absolute GDP itself, whenever the recovery starts, it will be from a much lower base. So even a 6 per cent growth rate in FY22-23 will get us to a much lower point in absolute terms than a 6 per cent growth rate in FY19-20 could have. This means the key metric to look at would be the year in which the real GDP could reach the same level as it was in FY19-20.

Based on the former Chief Statistician Pronab Sen’s Ideas for India paper, the chart below indicates when we might return to FY19-20 GDP level (dotted line). The realistic scenario predicts we’ll get there by the beginning of FY22-23. However, that scenario assumed a big fiscal demand push by the government. Given that it is nowhere in the picture still, the pessimistic scenario — where we’ll reach FY19-20 GDP level only in mid-2026 — seems to be getting real by the day.

(Data Source: Pronab Sen, Ideas for India)

Will We Be Scarred?

That brings us to the last point. Will there be a hysteresis or a ‘permanent loss’ in the economy because of our behaviour changing after living through the pandemic. Based on the history of human behaviour after a tail risk event, we think this is inevitable. What we have struggled for the last few months is to find a way to quantify the economic impact of this permanent scarring of our lives.

Read the full edition here.

Disclaimer: Views expressed on Anticipating the Unintended are those of the authors’ and do not represent Takshashila Institution’s recommendations.