India’s Financial Economy: Post 4

In this post we will take a step back from the Indian Economy and take stock of how the aggregate global economy is likely to get impacted by COVID. We will play close attention to the work of IMF and World Bank, both of which has come out with updated projections on the COVID impact on the global economy.

The IMF revised global growth for 2020 to -4.9% from -1.9% in their April assessment. In 2021 global growth is projected at 5.4% with recovery setting in around second quarter of 2020. This would still leave the overall 2021 GDP some 6.5% below pre-COVID estimates. World Bank estimates are similar outcomes. They expect a growth of -5.2% and 4.2% in 2020 and 2021 respectively.

Key drivers of the contraction

1. There is a sharp fall in consumption unlike other recessions where households use their savings to smoothen out consumption trends. This is because of the unique peculiarities of a self imposed demand and supply shock owing to lockdowns being imposed in most countries.
2. Since we are only expected to hit pre-COVID levels of GDP in late 2021 firms will most likely defer capex plans thus keeping investment spending muted for a fairly long time
3. The ILO has estimated that about 5.4% of the employment (in man hour terms) has been lost on Q1 of 2020 as compared to Q4 of 2019. In Q2 they expect this to rise up to 14%.
4. Global trade is expected to contract by 12% in 2020 exhibiting a sharper fall due to supply constraints and protectionist measures.
5. IMF expects the advanced economies to contract by 8% in 2020 and grow by 4.8% in 2021. Thus even in 2021, output will be lower than 2019 levels by about 4%
6. Emerging and Developing Countries are expected to deliver -3% in 2020 and 5.9% in 2021 respectively. The numbers would in absolute and relative to the April assessment look much worse if China is excluded. This is because China is expected to deliver 1% and 8% growth in 2020 and 2021 respectively.
7. The IMF expects the Indian economy to contract by 4.5% in 2020 and grow by 6% in 2021. The World Bank expects the Indian Economy to deliver -3.3% and 3.3% growth in 2020 and 2021 respectively.

Policy Response for Stabilization

1. Inflation has been muted with average inflation in Developed countries dropping from 1.3% in late 2019 to 0.4% in April 2020 and similar trends in Emerging Markets. So far it seems that the supply shocks in the economy are not having an inflationary impact.
2. This has created room for substantial policy action on both fiscal and monetary sides. For the G20 countries in aggregate, the fiscal response is about 5.8% of GDP while the monetary stimulus stands at 6.35%. As you would expect that Advanced Economies have extended greater stimulus.
3. This would lead to the Fiscal Deficit at a global level to reach 14% of GDP in 2020–21. Fiscal deficit is expected to come down next year but only to 8%. Again Advanced economies will run higher deficits in both years.
4. Global Public Debt to GDP is expected to rise by 19% from last year reaching an all time high of 101% of GDP. Due to a combination of high primary deficit and low growth, the deficit is expected to further expand in 2021–22 as well.
5. India’s fiscal response at 1.2% of GDP is significantly less than the aggregate EM fiscal response of around 3.10% of GDP.
6. In 2021 the IMF expects India to run a fiscal deficit of 12%, which is higher than the aggregate metric for Emerging Markets (10.6%). IMF also expects India’s Public Debt to GDP level to peak at 86% in 2022. The absolute increase from 2019 is around 14%, which is inline with the aggregate Emerging Market basket.

How does the Global Environment Affect India?

1. Exports: According to the Economic Survey, India’s biggest export partners in 2020 were USA (17%), UAE (9%) and China (10%). From a product perspective, largest components in commodity exports are Petroleum Products (14%), Gems and Precious Stones (12%) and Pharma and Chemicals (8%). From both these perspectives, India’s export growth will likely comeback only once the global recover sets in. India’s relative dominance in Pharma and Chemicals and Software Services segment will support stabilization in the interim. Recent commentary from the commerce ministry seems to suggest that June export performance is at 85% of average monthly trend after posting a sharp fall in both April and May.
2. Import Basket: Crude and Petroleum Products are the biggest components of India’s import basket. Global growth in a key driver of crude prices in the long term. Even though prices have rebounded from the lows in March, they are still down about 30% for the Indian Crude basket. But interestingly the price of fuel to Indian consumers are higher than pre-COVID levels. This is because both Central and State governments have hiked excise and VAT charges respectively in order to retain the bulk of this input price reduction as tax revenue. This is providing some stabilization to their fiscal accounts. The second biggest component of India’s import basket is Gold. Because of a sharp rise in Gold prices, imports of this commodity will automatically be significantly lower than pre-COVID levels.
3. Currency: The other linkage between global growth and the Indian economy is through the currency channel. We discussed this in detail in this article. Because of the sharp fall in output, central banks around the world have had to expand their balance sheet and bring down policy rates. Initially this led to a sharp reallocation of assets towards advanced economies. The Federal Reserve provided Dollar swap lines to many central banks in emerging markets. Most Emerging market Central banks have been prudent post the GFC and had built up adequate foreign currency reserves, thus providing them more ammunition to intervene in the currency markets in case of a sharp sell-off. Along with a re-opening of the economy, this led to some stabilization in capital flows towards emerging markets. I think in the medium the FX channel will primarily be driven by the monetary policy differential of India and the US with FPI flows being the key tool that drives this adjustment.