The outbreak of the Covid-19 pandemic was a natural experiment for economies around the world, including India. Past pandemics were not comparable in scale or were too far behind for us to have a clear idea of how the economy and businesses would react to the spread of Covid-19 and the lockdowns imposed to stop it.
There were some dominant narratives earlier in the year. The first was that while the pandemic is a simultaneous supply and demand shock, the latter would prevail and lead to a disinflationary cycle. A second was that a dollar shortage could emerge and world trade would enter a recession. Another belief was that public spending must be fast and high to save the economy at a time when consumption and investment were affected. As a result, borrowing costs for the sovereign would rise and the central bank might have to return to direct monetization of the deficit.
Nine months after the pandemic hit the Indian shores, some of these narratives have been turned upside down. And other trends that no one predicted have come to the fore.
Supply shock> Demand shock
Among the biggest surprises of the pandemic has come inflation. Inflation was expected to decline dramatically from the 6.5% it averaged in the fourth quarter of fiscal 2020. At its emergency meeting in March, where India’s monetary policy committee cut rates by 75 basis points, it said it expects the drop in core inflation due to lower fuel prices and weak aggregate demand.
The inflation rate, eight months lower, is at 6.9% with core inflation at 5.5%, the highest in almost two years.
What happened? Aside from supply-side pressures that kept food prices high, economists could not foresee the compensating margins that would build on various services. From transportation to domestic services, prices rose to offset the reduced and reluctant supply. Higher indirect taxes on fuel also played a role. Together these factors prevented even core inflation from falling, despite the Indian economy entering a recession.
Current account surplus to the rescue
The sharp contraction in local demand coupled with fractured global supply chains caused imports to drop dramatically. This was not unexpected, but the implications of India moving from a current account deficit to a current account surplus were not widely understood at the beginning of the crisis.
The surplus was supported not only by trade flows, but also by a strong recovery in capital flows. The result was that India posted a record current account surplus of 3.9% of GDP.
A current account surplus is nothing to celebrate for a developing country like India, but by definition it is also the difference between saving and investing in the economy. It is these precautionary and forced savings that came to the rescue in many ways.
The surplus also avoided pressure on the Indian currency and, perhaps for the first time in recent crisis years, the rupee held steady with the central bank fighting appreciation by creating reserves.
The government didn’t really spend much
The fiscal restraint, despite warnings to the contrary, displayed by the Indian government surprised almost everyone.
Data available in October detailed by BloombergQuint shows that spending has been flat over the past year at least through October. This despite the fact that an increase in liquidity in the markets has allowed the government to borrow quite comfortably.
The implications of restricted spending are not entirely clear yet. On the one hand, it is true that the economy seems to recover in sync with the easing of restrictions. Therefore, it could be argued that activity is recovering at full speed and did not need government support.
But economists worry that the scars of low government spending will show up later. The pain in the informal economy and the small business economy is not reflected in frequently tracked data. If there are big losses in wages and jobs among smaller companies, as many believe there are, after an initial push, consumption growth will stagnate at lower levels.
Corporate debt problems did not get worse
When the crisis struck, an extension of the bad loan pain that Indian moneylenders had been facing seemed inevitable. As a cushion, the Reserve Bank of India again allowed a one-time restructuring without a downgrade to bad loans.
As the deadline for that restructuring window approaches, the restructuring sought, at least by large companies, has been much less than expected. According to CRISIL, at least 99% of the companies it rates do not intend to seek restructuring. Two thirds of these entities were eligible. Requests for restructuring from small businesses, while more than those received from large corporations, are also smaller than anticipated. However, retail stress is likely to increase.
Contrary to intuition, large corporate borrowing fell in the second quarter of the financial year to its lowest level in five years, Credit Suisse data showed.
We went digital … almost too fast
Digitization has been an aspiration for Indian politicians in recent years. Hell, we even demonetized 86% of our currency to reach that goal, but to no avail.
Covid-19 accomplished what demonetization could not. With the majority of consumers and producers blocked, digital channels became the main way to make payments. Volumes have increased especially in retail payments. Between March and November, the value of transactions on the most popular unified payment interface went from just over 2 lakh crore rupees to Rs 3.9 lakh crore.
The bad news is that the initial push for digital payments didn’t actually wipe out cash. Preventive demand for cash meant that currency in circulation also increased along with digital payments. The final trend will clear up as the economy returns to normal.
Finally, a global trend that made a surprising amount of currency this year was the mainstream cryptocurrency.
Amid volatile global markets, cryptocurrencies like Bitcoin showed surprisingly stable gains. More importantly, he saw that large established payment companies were more accepting of cryptocurrencies.
By July, Visa and Mastercard had announced that they were expanding their cryptocurrency partnerships. In October, Paypal allowed the purchase, sale and spending of cryptocurrencies through its network. In December, Singapore’s DBS Bank said it would establish an exchange for digital assets, including cryptocurrencies.
India has been woefully behind in changing its attitude towards cryptocurrencies. The government and the RBI have yet to finalize their focus on whether to regulate or ban them. An election in favor of the latter will seem completely out of sync with the direction in which the world is moving.
Ira Dugal is editor of banking, finance and economics at BloombergQuint.
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