Thoughts on covid 19 recovery - sustainable recovery or release of pent-up demand and supply?

Has the Indian economy left behind Covid 19 and recovered? I confess to being confused by headline indicators of economic recovery and anecdotes and observations to the contrary. So how do we make sense of these conflicting signals?

Several headline indicators ranging from tax revenues, exports and imports, corporate revenues and profits, real estate prices and sales, consumer durables and non-durables spending, passenger vehicle sales, electricity consumption, and so on have rallied impressively since the second wave lows. There are ample formal signatures of recovery to argue that the Indian economy has put the pandemic behind. 

The smart pace of vaccinations (after the very slow start) and the flush of foreign venture capital inflows into Indian start-ups, coupled with the visible signs of recovery, have rekindled the animal spirits. It may not be incorrect to argue that the general optimism and spirits among investors have not been this high for several years. The equity markets have soared on the back of rising corporate profitability, a continuing globally synchronised irrational exuberance, and a definite and welcome expansion of the base of domestic equity market investors. So is the pandemic really behind us?

Given the nature of such predictions and the acute deficiency of good data on the informal economy, arguments in either direction have to rely on some theory, history, and observation and then make informed judgements. Fundamentally, those arguing that we have left the pandemic behind and those arguing against premise their respective explanations on their personal assessment of whether the recovery is broad-based enough.

Therefore any assessment of whether the recovery is broad-based enough is, given the lack of good and relevant data about the wide swathe of semi-formal or informal economy, purely a matter of personal judgement. Without being strongly connected to the realities of life outside our typical narrow urban and high income confines, personal judgements are fraught with problems. So any assessment has to be tempered with this humility. (Good field stories by journalists, screened for biases, are more useful than oped pieces by largely metro-based commentators)

There is little doubt that the salaried classes and the corporates (at least the larger and middle-sized ones) have come out of Covid 19, perhaps with even stronger balance sheets. But given the small size of this segment, the sustainability of their performance depends critically on sustenance of aggregate demand in the remaining economy. Outside of food and other essentials, a large, perhaps the major, share of consumption of fast moving consumer goods and consumer durables comes from the broad base of consumers outside of the small middle-class and above. Have they recovered enough from Covid 19 to be able to sustain the demand going forward? 

Since the pandemic, this blog has consistently held that the pandemic has adversely impacted the lower middle class and below (who make up the vast majority of economically active population). Further, like elsewhere in the world, and due to the nature of the lockdowns and differences in how it impacts different people, the formal sector and the salaried class have not only come out unscathed but perhaps even better off. The lockdowns have led to accumulation of household disposable incomes among the better off. And businesses have shed excesses, improved productivity and squeezed labour. This coupled with the wealth effect from capital gains on financial assets, the main source of wealth of the richer Indians, have even flared bubbles in areas like luxury real estate. A combination of this makes me slightly inclined to the K-shaped recovery camp. 

It's not that all the macro indicators point to a recovery. Important indicators speak otherwise. Credit growth remains stuck at low levels, private investment intentions do not signal expectations of promising future, labour force participation rates remain significantly below pre-pandemic levels etc. Then there are the good proxies of distress which have risen or are staying elevated - persistently high demand for NREGA work, gold loans issuance and their liquidation by lenders have soared, large numbers of small private schools have been closing and government schools have been witnessing a surge in admissions, significant shares of services jobs (retail shops, restaurants, tourism etc) have not been restored etc.

More than anything, it is evident to any observer that the economy suffered an unprecedented negative shock during the lockdown and the subsequent second wave. Businesses folded up, millions lost their livelihoods, migrants returned home. Millions depleted their life savings, both due to the loss of livelihood and also on Covid expenses within the family. And the repairs cannot be so quick and easy without external support. It's not at all clear that these disruptions have been anywhere close to being repaired enough for these actors to restart activity. And now inflation is threatening to squeeze real incomes. Of course, it's also plausible that the damage has not been as bad as is being thought of and the repair is well underway. 

In Can India Grow?, we had argued that the core of India's economic expansion stood on very narrow foundations. We argued that drastically broad-basing this foundation (of productive firms, farms, and labour, and investible capital) is critical to create the conditions for sustained high growth rates to match those of the North East Asian economies. Further, in the circumstances, any growth spurt has to come from unsustainable growth in some parts of the economy. The pandemic ended up boosting the strength of this narrow base. But the growth boost from the narrow base on its own can only go so far, especially if the remaining parts of the economy are distressed. 

Having argued in favour of the likelihood of a K-shaped recovery, it's also quite possible that the growth boost from the narrow base will provide the momentum and also buy the time required to help overcome the distress among the smaller firms, informal economic actors, and lower income households. In a continental economy, that likelihood is a non-trivial possibility. It's also possible that the agricultural economy, which largely escaped the pandemic and has grown at a healthy clip, has cushioned rural distress.

It's important to be cautious about drawing inferences about the economy. The booming equity markets, rising tide of venture capital inflows and birth rates of unicorns, and healthy headline indicators can spark complacency across. In many respects, as highlighted in Can India Grow, India has a two-track economy. The animal spirits in one part of the economy can co-exist with distress and pessimism in other parts. It can be fatal mistake to confuse a release of pent-up demand with more broad-based recovery.

In any case, only the coming months will tell us definitively enough about the extent of recovery. Anything till then, on all sides, is pure subjective assessment.