Conclusions Paper

May 2020

INDIA: ECONOMIC IMPACT OF

COVID-19
In conversation with Ananth Narayan, Associate Professor
of Finance at SP Jain Institute of Management and
Research


INDIA: ECONOMIC IMPACT OF COVID-19

Unlike with the 2008-09 Global Financial Crisis (GFC), India entered the Covid-19 crisis on a
weak footing. Growth was slowing, the fiscal position was precarious, a number of key sectors
were distressed, as was the financial system. Given the severity of the crisis, the Indian
economy will undoubtedly suffer a body blow and it will take time to recover. The silver lining,
however, is that Covid presents a unique opportunity to unleash bold reforms. At recent
online sessions of the India CEO and India CFO Forums, Ananth Narayan, Associate
Professor of Finance at SP Jain Institute of Management and Research, outlined what the next
few quarters could be like for India.

ENTERING THE CRISIS WEAKENED...

In at least three ways, the Indian economy entered the crisis far
removed from being in the ‘pink of health’:

A weak financial
system, with crisis-
ridden N BFCs and an
overhang of N PAs...
… chronically stressed
sectors such as power,
real estate, shipping,
airlines and telecom...
...and a lack of jobs
• First, the very engine of economic growth – the financial
ecosystem – was fragile, and poorly placed to extend credit to
industry or consumers. This is despite India having a much
smaller banking loan book than China: 50% of GDP
compared to over 200% in China. Officially, banking non-
performing assets (NPAs) are pegged at 8.6% of advances, but
the real number is closer to 12%. This is because of the
generous forbearance that is allowed for loans to MSMEs and
certain classes of real-estate. Moreover, unlike with banks,
NBFCs are not subject to proper asset quality reviews and
hold large volumes of non-performing loans themselves.
• Second, several key sectors – including real estate, power,
airlines, shipping, telecom, automobiles and a large proportion
of MSMEs – were in a state of chronic distress. At 68.6%,
capacity utilisation in December 2019 was at a historic low.
• Third, there are simply not enough job opportunities for a
young and growing population. India’s ‘demographic dividend’
is considered to be one of its greatest advantages. However, it
has been unable, so far, to reap this dividend. In fact, the
workforce participation rate is just 34% (and declining), and
women account for just 17% of GDP. There is also a huge
under-employment issue, with 44% of the population engaged
directly in agriculture, which accounts for just 16% of GDP.
Rural youth unemployment is a staggering 20%.

...AND WITH A HISTORY OF ‘PRINT AND SPEND’

India is already
running a huge fiscal
stimulus
Some might criticise the government for being fiscally too prudent
even in the face of a devastating crisis. The reality is that it has
been following a ‘print and spend’ policy for years. Officially, the
fiscal deficit (Centre + states) is 5.9% of GDP; in fact, after
including PSU borrowings, it is closer to 9.7%. At the same time,
domestic corporate and household savings were just 6.5% of GDP
in FY19, while net FII inflows into debt and equity have averaged
less than USD 3 billion a year for the last 5 years. (In March alone,

IMA India, 2020. All Rights Reserved. 1


There are no guiderails
on which to base
forecasts, but the
prognosis is weak
M ost of the economy is
locked down and will
take time to recover
Contract workers and
the self-employed will
suffer the most
The government will be
forced to ‘print and
spend’ even more…
IMA India, 2020. All Rights Reserved.
there were FII outflows worth USD 16 billion from India.) Thus,
to bridge the widening gap between government borrowings and
savings, the RBI had been printing money, purchasing
government bonds and transferring large surpluses to the
government. This helped to prop up growth. In fact, were it not
for the 12.5% growth in government spending in the third quarter
of FY19, economic growth would have been under 3%, compared
to the official 4.5%.
BRACING FOR AN ECONOMIC ‘BODY BLOW’
In forecasting the impact of Covid-19, the only historical reference
point is the Spanish Flu, which occurred a century ago, went on
for three years and came in three separate waves. Thus, India is
today flying blind in many respects. What is certain, however, is
that it will face significant economic stress and perhaps social
unrest. Many economists are projecting FY21 growth at 1-2%, but
realistically, the economy is likely to contract mildly (~-1%).
Moreover, unemployment will balloon, the fiscal deficit will widen
dramatically, inflation will perk up and the Rupee will come under
downward pressure. This outlook rests on several assumptions:
• 64% of the economy has been under complete lockdown
for over a month, with no guarantees as to when it will open
up. These sectors which will open up only gradually,
operating perhaps at 70% of capacity in the first month, at
90% three months down the road, and may thereafter grow
at a 5% rate for the remainder of the year. The 36% of the
economy that has remained ‘open’ – agriculture, food
products, healthcare, utilities and public services – can at best
hope to grow by 5% for the year as a whole. None of this
accounts for the impact of the lockdown on the financial
health of companies.
• Currently, just 17% of India’s workforce is salaried. 37% of
workers are casual/contract labour on daily wages and 46%
are self-employed. Thus, roughly 83% of the workforce
comprises of self-employed and daily wage workers, who
are likely to face deep distress. This will filter down into
businesses across multiple sectors, and into the financial
system. Over a quarter of all fresh advances – including loans
for commercial vehicles, construction equipment, transport,
hospitality and MSMEs – are likely to come under scrutiny
solely because of Covid-19. This could cause NPA levels in
banks and NBFCs to spike to 20% or more.
• On account of these factors, the government will have no
choice but to ‘print and spend’ on a bigger scale. This
spending will be used to provide emergency medical relief;
put money and food into people’s hands; ensure critical
government services such as power, water and municipal
services; shore up MSMEs; and bail out banks and NBFCs.
2


All of this will cost a minimum of 2-3% of GDP. Factoring

in a collapse in tax collections and disinvestment receipts
(which are budgeted at Rs 2.1 trillion), and even if non-
essential capital expenditures get deferred, the overall deficit
will jump to 16% of GDP or higher.
• Unlike the developed world – Europe, Japan and
… but it cannot do so
America – India is in no position to endlessly ramp up
endlessly
spending. The US plans to increase the deficit to 10% of
GDP, and Japan to as much as 20%. However, India does
not have the advantage of printing a ‘hard currency’ that can
be ‘exported’. Further, while ramped-up public spending
might temporarily spur growth, the excess demand it
generates will not necessarily translate into domestic output
or jobs. Instead, in the absence of domestic capacity, it will
push up imports.
Risks on the horizon: • In the short run, the RBI has adequate reserves to prop
inflation, a rising up the Indian currency. Moreover, while exports and
CA D, a falling remittances have collapsed, so have imports. This means that
Rupee… India will probably see a current account surplus rather than
a deficit this year. However, a bit further out, excess liquidity
will drive up inflation, fuel the demand for imports, push up
the CAD and pull down the currency. Still, considering that
the Rupee was over-valued by nearly 16% before the crisis, a
gentle depreciation may actually prove beneficial.
… and possibly, a
• A large fiscal deficit also raises the risk of a ratings
ratings downgrade
downgrade. India is currently at the lowest investment grade
(BBB-), and were it to fall by one notch, it would enter the
junk-bond category. Not only would this be a political ‘hot
potato’, but it would also cause foreign investment to dry up.

POST-COVID: STRONG POLICY REFORMS ARE IMPERATIVE
India is at a crossroads, Today, the government finds itself at a policy crossroads. In the
but is likelier to opt for worst case, it could respond to the crisis by reverting to 1970s
reforms than populism style populism, which might include re-imposing the wealth tax,
hiking income tax rates, creating a new ‘licence Raj’ and even
closing off the economy to imports and foreign investment.
Hopefully, though, it will use this as an opportunity to drive
through critical reforms in several areas, including land and labour
laws, contract enforcement, judicial processes, infrastructure, and
other constraints that hamper the ‘ease of doing business’ in India.

Focus areas: the
financial sector…
… stressed industries…
• The financial sector needs to be cleaned up so that it can
start funding economic growth. This might include setting
up a ‘bad bank’ that absorbs stressed assets, and following
that up with governance- and market reforms.
• Chronically stressed sectors such as power, real estate,
airlines and shipping, telecom and MSMEs need to be made
viable. For MSMEs, the government may choose to provide
a line of credit or guarantees to the extent of taxes paid by

IMA India, 2020. All Rights Reserved. 3



the entity in the previous year. Essentially, this would enable

a flow of funds at reasonable rates, guaranteed by past tax
payments.
• Factor market reforms are required to create jobs and make
… factor market India a more attractive investment destination. India should
reforms… also leverage today’s favourable external conditions, such as
subdued oil prices (to build up its oil reserves) and anti-
China sentiment (to position itself as an alternative
destination). However, China’s loss will not automatically be
India’s gain. Even during the Sino-US trade war, it was
countries such as Vietnam and Bangladesh, with their
stronger factor markets, that drew in supply chains from
China. India must also be aware that as the world moves
from globalisation to localisation, any fiscal stimulus that is
not accompanied by reforms will simply drive up imports.
The imperative is to be able to manufacture domestically,
thus creating jobs and output that cater to the local
economy, and which in time, may even produce a surplus for
export.
… and health and • Focus on healthcare, nutrition and education. On the one
education hand, this will mean building employable skills that can
secure jobs for India’s most important assets – its youth. On
the other hand, it will mean spending more on fostering a
healthy and productive workforce. Currently, nearly 40% of
five-year-olds in India are under-nourished and the money
spent on well-being of the youth is abysmally low. Changing
this would go a long way.

TURNING CRISIS INTO OPPORTUNITY

India still enjoys
goodwill abroad
The silver lining for India in this time of crisis is that it continues
to enjoy immense goodwill abroad. However, it will need to
capitalise on this by focusing on health and education, and
bringing in major economic reforms. If any government can
achieve this, it is the NDA, which enjoys enormous political
capital and a strong track record that includes the Insolvency and
Bankruptcy Code (IBC), the GST, and corporate tax cuts. Finally,
as the 1991 reforms proved, there is no better time than a crisis to
effect sweeping change.

The contents of this paper are based on discussions of The India CEO and CFO Forum sessions from across the
country with Ananth Narayan, Associate Professor of Finance at the SP Jain Institute of Management and
Research in April 2020. The views expressed may not be those of IMA India. Please visit www.ima-india.com to
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Covid-19 Policy Dilemmas:
A Party Perspective
Exclusively for members of IMA India's CEO Forum
Tuesday-Wednesday, May 05-06, 2020

Rajat Sethi, BJP

Advisor to State Governments

An engineer from IIT Kanpur, a public policy graduate from Harvard

and an MBA from MIT Sloan, Rajat played a key role in the BJP’s
electoral successes through his innovative use of technology.
Subsequently, he has been Advisor to the Chief Ministers of
Jharkhand and Manipur and contributes actively to the
BJP’s economic thought process.