A skewed recovery, and systemic headwinds
August has been the best month (so far) in terms of economic activity since the imposition of a nation-wide lockdown in India on March 25. However, the ongoing economic recovery is skewed in nature and faces systemic headwinds from within.
Services in contraction zone, even as backlog increases
Purchasing Managers’ Index (PMI) for August shows that the service sector continues to be in contraction mode for the sixth consecutive month. To be sure, August has seen a faster recovery than July. Respondents however reported “a further weakening of demand conditions” which among other things was also a result of “among the steepest” contractions in new export orders received by Indian service providers. Ongoing lockdown restrictions have meant that firms are unable to process previously placed orders, even as job losses continued for the sixth consecutive month, the press release from IHS Markit, which conducts the survey, said.
See Chart 1: PMI industry and services
Employment intensive sectors were hit the hardest in the first quarter
Gross Value Added (GVA) data for the April-June quarter when read with sector-wise employment share numbers narrate a grim story. The sectors which have suffered the biggest contraction also have the largest share of employment. Trade, hotels, transport, storage and communication (18.5%); manufacturing (12.1%) and construction (12.1%), which together account for 42.7% of total employment according to the 2018-19 Periodic Labour Force Survey, have suffered the biggest contraction in the first quarter. This underlines the possibility of job losses having a cascading adverse effect on future demand.
See Chart 2: Scatter plot of employment share and contraction in GVA
Ongoing recovery could get jeopardized once pent-up demand is exhausted
Rising infections that prevented a return to normal service sector activity, continuing job losses, and a massive negative shock from the contraction in the April-June quarter means that the economy lacks a solid demand anchor. Consequently, some of the ongoing recovery could just be one-time pent-up demand. Once this is exhausted, even the nascent recovery that is being seen in some sectors could dissipate. Firms seem to expect this. In the Reserve bank of India’s Industrial Outlook Survey, conducted in April-June 2020, net expectations of order bookings in the July-September quarter were the lowest since June 2009.
See Chart 3: Net expectation of order books
The situation emphasizes the importance of a co-ordinated policy response. “We believe policymakers have an important role to play in the recovery process beyond traditional monetary and fiscal stimulus. This would entail efficient re-allocation of capital from sectors that are not working to those that are. Improving the Insolvency and Bankruptcy Code procedure is a key step here”, said a research note by Pranjul Bhandari, Chief India Economist at HSBC Securities and Capital Markets India Private Limited.