Peering into 2021

Macroeconomics in 2021 will turn on consumer demand and firm resolution

The light at the end of the tunnel, of the health dimensions of the pandemic, is now visible. There are many difficulties in conventional data, but a transformation is now unmistakable. As an example, the official data for Mumbai showed the first Covid-19 death in March and peaked at 136 deaths on June 20. The values are now at about three deaths per day. Each neighbourhood and each community in India is at a different place on the epidemic curve, but broadly we are at a late stage of the epidemic. A reduction of deaths could have come from people huddling in their homes, but this is not the case. The mobility data shows business resumption and employment have significantly come back from the lows of April.

However, it is not yet time to declare an economic recovery. Household consumption is well below pre-pandemic levels. Interaction-intensive services have not recovered, and the process of reallocation of capital and labour on the production side to other objects of desire has not yet completed. Alongside this, households are afraid about the future and have increased saving. Putting these together, there is a large demand shortfall in the economy. The feedback loops of macroeconomics are at work: When households demand less, firms get reduced revenues, which feeds into reduced expenditures by firms, and thus reduced household income.

The economic stress of 2020 has generated an inventory of troubled debt contracts. Many borrowers have benefited from moratoriums, which helps for a while but must inevitably come to an end. At a future date, many borrowers will face difficulties in debt servicing. Among financial firms, many lenders will face balance sheet stress. There will be a surge in defaults of non-financial and financial firms.

We will need institutional mechanisms that process failure in an orderly way. We are in a pre-2016 state when it comes to default by non-financial firms. There is no systematic institutional framework for handling default by financial firms, though the Reserve Bank of India has scored two nice successes with improvised market-based methods for handling bank failure. Mac­ro­­e­conomic performance in 2021 will be dominated by these three problems: Household demand revival, households and non-financial firms that are under stress on debt repayments, and stressed financial firms.

Private projects “under implementation” at Rs 36 trillion in December 2020 were slightly lower than the value of Rs 38 trillion a year ago. This comes in the context of a sustained decline over a longer period, where the peak value in nominal rupees was observed in December 2011. While a part of the economy is flourishing, many non-financial firms are facing one or more of the three problems: Sluggish demand, financial stress in the firm, and constraints in accessing finance. Put together, 

this has added up to an environment of subdued private investment.

Illustration: Ajay Mohanty

There has been significant growth in public investment, which is mostly in infrastructure. In December 2011, government projects “under implementation” were Rs 34 trillion. This swelled to Rs 83 trillion in December 2020. This reflects the shift away from private participation in infrastructure. But we must remember that infrastructure assets are a means to an end. The purpose of infrastructure assets is to create enabling conditions for private investment in firms that will utilise the infrastructure of transportation and communications. By 2020, infrastructure constraints were less important in shaping the thinking of private firms. In addition, government-led investment has lower efficiency in translating money into performance.

The labour market data gives us a good insight into macroeconomic conditions. In December 2020, 427.5 million people were employed. This was below the 439 million seen in December 2019. This comes in the context of sustained sluggishness in the number of persons employed, visible in the time-series which starts in January 2016. In the meantime, population growth has given more people of working age. This constitutes a fundamental challenge for public policy. Almost all jobs flow from private investment, so solving the problem of employment requires solving the problem of private investment.

Headline inflation, i.e. year-on-year consumer price index (CPI) inflation, surged in December 2019. It has been uncomfortably high in the period thereafter. The latest value of 6.93 per cent for November 2020 remains above the upper bound of the target range from 2 to 6 per cent. However, in an environment where demand conditions in the economy are sluggish, it is hard to argue with the decision of the Monetary Policy Committee about interest rate setting. It is likely that normalisation of the economy will result in improvements in supply and bring inflation back into range.

This is the macroeconomic situation at the start of 2021, which will feed into the budget-making process, the results of which will be unveiled on February 1. Tax revenues will be subdued. The size of government is small when compared with the magnitude of the problems faced in terms of the shortfall of household demand and private investment. Sound, conservative public finance strategy will generate a bias in favour of being careful in spending or running deficits. Despite these constraints, the debt/gross domestic product (GDP) ratio is likely to continue to rise, through a combination of high borrowing and weak GDP growth.

Policymakers can assist the recovery of the economy by addressing the problems of private investment at the root cause. Many researchers have written, in recent years, about the difficulties of private investment after the peak value of December 2011, and there is a well-developed body of knowledge about what has changed. In addition to these long-standing issues, there is immediate pressure on the resolution frameworks for financial and non-financial firms. Establishing conditions for sustained growth will be assisted by cleaning the slate, through the resolution of stressed firms, so that we get back to a large fraction of the overall balance sheet being in healthy firms.

The writer is an independent scholar