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The 5 factors that will determine the shape of the Indian economy in 2021

Economic recovery from pandemic has been faster than expected, but with Budget set to be presented next month, these factors need to be taken into account.

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India’s economic recovery from the Covid-19 pandemic has been faster than expected, and yet, important risks to the economy remain.

In thinking about the Budget process for 2021, we need to establish a perspective on the forces at work.

There are five things to watch out for that will determine the shape of the Indian economy in 2021.


Also read: Why Indian economy seems set for revival in the new year after a tough 2020


1. The pandemic

An array of studies shows antibodies in a large fraction of the population, with the corresponding decline in the number of people who are susceptible, thus slowing down the pandemic. Anecdotal evidence shows sharp gains — for example, there have now been days in Mumbai with zero deaths attributed to Covid-19 in the official data. The spread of the virus has slowed down in almost all major states of India, with the reproduction rate falling below one.

Vaccine production has started on a large scale everywhere, and many in India will now be able to get vaccinated. This will further help reduce the number of people who are susceptible to Covid-19. Every day, more people are getting comfortable about the dangers, and are increasing their economic activity.

2. Consumer demand

In the period of the lockdown, consumer demand crashed. Part of this was mechanical — if people could not go out to visit markets, there were no sales. Services like transport and hospitality saw a collapse.

After the lockdown, consumer demand was down as first, people’s incomes had contracted, and second, even when incomes started rising, there was uncertainty about whether this was going to be a steady increase or the economy could collapse again. As long as deaths were rising and hospitals were full, there was fear that the country could collapse into a lockdown again. This kept consumer demand low.

These fears have abated with the falling number of deaths and the ability of the health system to cope with Covid patients. This has, therefore, led to a reduction in uncertainty in the economy and an increase in consumption demand.

However, there are fears that lower employment levels mean lower incomes, which could keep demand suppressed, after it picked up due to pent up declines.


Also read: Modi govt is planning to set up DFIs, but it needs to figure out sources for funds first


 

3. Investment

The most important determinant of economic buoyancy in India is private investment. Higher uncertainty pushed investment demand down. As the uncertainty in the economy reduces, businesses will have a more stable environment to invest in.

However, the balance sheets of many companies, particularly small businesses, have been impaired by the crisis. The RBI gave companies with bank loans a moratorium for the period of the lockdown as companies were unable to repay loans. This moratorium did provide help, but lower demand, fixed costs and the requirement to pay interest on existing loans put pressure on companies.

Impaired balance sheets of firms — financial and non-financial — will exert a significant drag upon the extent of investment revival. The old agenda of firm resolution remains highly important. The Insolvency and Bankruptcy Code needs to come back into action, and we have to go back to the FRDI Bill in order to establish a resolution mechanism for financial firms.

4. Fiscal deficit

The contraction in the economy meant the government’s tax revenue fell sharply. The fiscal deficit for 2020-21 is expected to be in the range of 6.2 to 6.5 per cent.

The capacity of the government to spend more will depend on the level of deficit. If the debt increases beyond comfort levels, then next year too, the government’s capacity to spend further will remain impaired.

5. Inflation

In the last few months, India has been seeing a rise in inflation. Initially, everyone thought it was caused by supply side issues caused by the lockdown, as demand was clearly suppressed.

But now that supply side issues and transportation bottlenecks have long been addressed, inflation still remains higher than the target, and even beyond the band around the target put in place by the RBI. Higher inflation, particularly in food, not only affects the spending capacity of the poor, but also creates greater uncertainty for businesses.

The hard-won credibility of the RBI in the post-2015 period — of having a focus upon inflation and having the tools to fight it — is now coming under question. The government and the RBI need to stay firm on the inflation targeting framework that has helped stabilise India’s macro economy.

Ila Patnaik is an economist and a professor at National Institute of Public Finance and Policy. Views are personal.


Also read: Relaxing inflation target for growth isn’t necessarily good, Modi govt must assess idea well


 

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3 COMMENTS

  1. Writer miss the Ladakh standoff factor. It will not resolve any time soon, bleeding India resources profusely, esp arm racing will divert much budget spending.

    China FDI and industrial activities in India will drop to bottom under Godi banned policy.

    1) Covid
    Nobody know what’s going to happen if new variant strains will work against India herd immunity. Virologists have found some recovered with antibody has reinfection again, weakening body immune system each time.

    I highly suspect India infections already cross high ratio of herd immunity when its infection curve started to show bell curve dropping since Oct2020. By Sep2020, sampling test shown 33% Delhi population has COVID antibody, 85% in Pune.

    Vaccines will take years to roll out in India. With only 3~6mths protection, it will be impossible for India to repeatedly vaccinate 70~90% 1.4Bils Indians.

    2) Consumption
    With India economy plunge, export & remittance hit by global economy dipping, 44yrs highest jobless rate at 37%, COVID, farmer protest, etc, expenditure income will fall, so consumption drop, retail & business will employ less…in a vicious cycle.

    3) Investment
    Global FDI will drop. As domestic consumption drop, domestic investment will also shrink. Another vicious cycle.

    4) Deficit
    India debt to GDP ratio already hit unsustainable 90%. At 8% interest, most revenue collected will goes to paying interest. More borrowing is required to pay off interest while sustain budget.

    With fast shrinking tax revenue, high expenditure, deficit will be widening. There are little fiscal tool to stimulate economy and consumption.

    5) Inflation
    This is double sided sword Godi has been utilizing for fake GDP growth, fuel by high inflation. In 2019, GDP growth 4.2% fueled by 6% inflation. In 2020 its -7% ~ 30% shrinkage fueled by 8% inflation and $500Bils borrowing.

    In 2021, there will be no more possibility for another huge COVID $500Bils stimulation. High Inflation with rupees depreciation will bite the household disposal income hard, further damping consumption.

    As a whole, 2021 will be tough year for India who has no huge reserve to stimulate like China, while facing uncontrollable COVID outbreak. There is likelihood another shrinking of GDP compare to 2019 until 2022. If more confrontation break out with China, then India economy will spiral downward into crisis.

  2. About a month back, in one of your videos, you had said that at present inflation is lesser problem and growth is important. But, now you have referred to RBI’s ability to fight inflation. What is the reason for this change of view?

  3. Views r so simplistic as if explainimg a 6 yr old she assumes on loss in employment ,all factors of production running at 90% plus,good investment

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