August has been the best month (so far) in terms of economic activity since the imposition of a nationwide lockdown in India on March 25. However, the ongoing economic recovery is skewed in nature and faces systemic headwinds from within.
Services in shrinkage zone, even when accumulation increases
The Purchasing Managers Index (PMI) for August shows that the services sector remains in contraction mode for the sixth month in a row. Certainly, August has seen a faster recovery than July. However, respondents reported “further weakening in demand conditions” which, among other things, was also due to “among the steepest” contractions in new export orders received by Indian service providers. Ongoing lockdown restrictions have meant companies are unable to process previously placed orders, even as job losses continued for the sixth month in a row, according to the press release from IHS Markit, which conducts the survey.
See Graph 1: PMI Industry and Services
Employment-intensive sectors were the most affected in the first quarter
The gross value added (GVA) data for the April-June quarter, when read with the employment share figures by sector, tell a grim story. The sectors that have suffered the greatest contraction also have the highest share of employment. Commerce, hotels, transportation, storage and communications (18.5%); Manufacturing (12.1%) and construction (12.1%), which together represent 42.7% of total employment according to the 2018-19 Active Population Survey, have suffered the greatest contraction in the first trimester. This highlights the possibility that job losses have a cascading adverse effect on future demand.
See Graph 2: Scatter diagram of participation and employment contraction in the GVA
Ongoing recovery could be compromised once pent-up demand is exhausted
Rising infections that prevented a return to normal service sector activity, continued job losses, and a massive negative impact from the contraction in the April-June quarter mean the economy lacks a strong demand anchor. Consequently, part of the ongoing recovery could simply be a pent-up lawsuit. Once this is exhausted, even the incipient recovery that is being seen in some sectors could dissipate. Businesses seem to expect this. In the Reserve Bank of India’s Industrial Outlook Survey, conducted in April-June 2020, net order book expectations in the July-September quarter were the lowest since June 2009.
See Graph 3: Net expectation of order books
The situation emphasizes the importance of a coordinated political response. “We believe that policymakers have an important role to play in the recovery process beyond the traditional monetary and fiscal stimulus. This would imply an efficient reallocation 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 from Pranjul Bhandari, Chief Economist for India at HSBC Securities and Capital Markets India Private Limited.
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