Brace up for recession
In February this year, a restaurateur friend turned optimistic. Business was back to 70 per cent of pre-Covid days and things could only get better. There could be no stronger signal that India’s economy had turned the corner. Experts had predicted that restaurants would be the last places to see a full recovery. They are closed spaces where masks have to be taken off to eat. Customers were expected to be scared of returning to this basic normal behaviour after a year of social distancing. So, if people were back, other parts of the economy would be on their road to recovery.
The wave has hit rural areas too. Apart from the unimaginable human tragedy, it could cut farm output and disrupt food supplies, causing food prices to rise.
As we now know, this optimism was short-lived. Within a month, lockdowns began across major metropolises. Car sales, which had recovered in the first three months of this year, dropped sharply in April. CMIE’s jobs data tells us that about 73 lakh people lost their livelihood over the month, and because of lockdowns, the number of people actively looking for work dropped to its lowest level since May last year. CMIE’s consumer sentiments index, which had seen a steady rise from November last year, dropped below that level in early May. Less than five out of every 100 people surveyed, expected their incomes to rise this year.
Lockdowns shut down factories and businesses in key industrial states like Maharashtra in April and May. Fuel consumption in April dropped to its lowest level since September 2020. Railway freight slipped to below November 2020 levels. Finished steel production dropped below June 2020 output, as did steel consumption. Some of this was because of supply shortages caused by lockdowns. However, as the example of tractor sales shows demand dropped at a faster pace. CRISIL’s data says retail sales of tractors dropped by 40-45 per cent in April compared to a month earlier, but wholesale supplies to dealers dropped by only 20-25 per cent.
This is a repeat of what we saw during the first Covid lockdown of 2020. Sales of goods dropped sharply across industries in April. The trend is most likely to have continued in May as more cities came under lockdowns. Most companies will see their sales volumes drop in the first quarter of this fiscal, even if a general rise in prices stems the fall in revenues. Last year, there was a global recession which caused raw material prices to collapse across the world. This helped India’s big corporates make record profits, because costs dropped faster than the drop in revenues.
This year, the picture is different. All other big economies are opening up. And as these countries begin to achieve their vaccination targets, economic activity is likely to revive, unleashing a year of pent-up demand. This recovery in the developed world is already causing a big rise in the prices of fuel and other industrial inputs. Indian companies will not be immune to this, since domestic prices of raw materials are influenced by the global commodity cycle. That means input costs will go up. If India’s second wave continues for longer, and if there is a third wave, then we will see a sharp fall in demand. Sales will continue to fall, but input costs will rise. This could mean that corporate profits will shrink this year, instead of expanding.
India’s stock market boom in 2020 was entirely rational. It tracked the expansion in profits, even though the economy tanked. Markets go up as a whole when the share of profits relative to interest and wages goes up. That is exactly what happened in India in 2020. Real wages fell and the RBI ensured that interest rates remained low. If profits contract this year, there is a danger that the markets will drop in response.
On the face of it, fluctuations in the stock markets are par for the course. However, in an economy like India, where the top 1 per cent of households drive a large part of additional consumption demand, stock market falls affect consumer sentiments. People who invest in markets or have significant mutual fund portfolios, tend to track their financial wealth on a regular basis. When markets go up it generates a ‘wealth-effect’ amongst such investors. They feel more confident about buying new cars, upgrading their refrigerators or even spending more on holidays. The reverse happens when markets fall. Affluent households with financial investments cut back on discretionary spending.
If private profits shrink, corporate sector jobs will also take a hit. People will either not get increments, or have to take pay cuts, and in some cases even lose their jobs. Again, these people form the backbone of India’s consuming classes. If their income reduces, demand will shrink further, forcing companies to cut prices. It is a vicious cycle where input prices, determined by global growth, will rise, while the prices of finished products will fall. Companies will cut back on production to meet the lower demand. That means they will have no reason to invest in new factories or offices.
There is another warning sign for India’s economy and that is coming from the rural sector. We are seeing reports of Covid spreading to villages in this wave, and our healthcare system is simply not equipped to handle that. Along with the unimaginable human tragedy, this could also affect the Kharif sowing season. This could reduce farm output and disrupt food supplies causing food prices to rise. That will be a double whammy — high food inflation in the middle of low income.
One can only hope that the babus in our ministries are reading these signals and are working out a detailed plan on how to tackle it. We have already witnessed how overoptimism about Covid turned out. Hopefully, the government will prepare for a worst-case scenario this time, rather than hope that things will be resolved on their own.
The author is a senior economic analyst
