The Pandemic Economy: Trends That Surprised  Amid The Covid-19 Outbreak
A financial trader reacts as he works at his computer screens at the Frankfurt Stock Exchange. (Photographer: Ralph Orlowski/Bloomberg)

The Pandemic Economy: Trends That Surprised Amid The Covid-19 Outbreak


The outbreak of the Covid-19 pandemic was a natural experiment for economies around the world, including India. Past pandemics were either not comparable in scale or too far back for us to get a clear sense of how the economy and business would react to the spread of Covid-19 and the lockdowns imposed to curb it.

There were a few dominant narratives early 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 dollar shortage may emerge and global trade would go into a downturn. Another belief was that government spending must be swift and large to save the economy at a time when consumption and investment took a hit. As a result, borrowing costs for the sovereign would surge and the central bank may have to return to direct monetisation of the deficit.

Nine months into the pandemic hitting Indian shores, some of these narratives have been turned on their heads. And other trends that no one predicted have come to the fore.

Supply Shock > Demand Shock

Among the bigger surprises of the pandemic has come from inflation. It was expected that inflation will ease sharply from the 6.5% it averaged in the fourth quarter of FY20. In its emergency meet in March, where India’s monetary policy committee cut rates by 75 basis points, it said that it expects the fall in core inflation due to lower fuel prices and weakness in aggregate demand.

The inflation print, eight months down, is at 6.9% with core inflation at 5.5%, the highest in nearly two years.

What happened? Apart from the supply side pressures which kept food prices high, economists failed to foresee the compensatory margins that would be built into various services. From transportation to household services, prices rose to counter the reduced and reluctant supply. The higher indirect taxes on fuel also played a role. Together, these factors prevented even core inflation from falling, despite the Indian economy going into a recession.

Now, as some of the supply disruptions ease, a rise in global commodity prices accelerated. Normalising demand will also take away any incentive for manufacturers to cut prices sharply. This may keep inflation high despite loss of aggregate demand.

Current Account Surplus To The Rescue

The sharp contraction in local demand along with fractured global supply chains meant that imports fell sharply. This was not unanticipated but the implications of India moving from a current account deficit to a current account surplus were not widely understood at the start of the crisis.

The surplus was backed not just by trade flows but a very sharp pick-up in capital flows. The result was that India reported a record high 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 savings and investment in the economy. It is these precautionary and forced savings that came to the rescue in many ways.

Prime among the benefits of  the current account surplus – keeping government borrowing costs in check and warding off the need for direct monetisation of the government deficit by the Indian central bank.

The surplus also prevented pressure on the Indian currency and, for perhaps the first time in recent crises years, the rupee was stable with the central bank fighting appreciation by building reserves.

The Government Didn’t Really Spend Much

The fiscal restraint, despite advisories to the contrary, shown by the Indian government surprised almost everyone.

Data available under October detailed by BloombergQuint shows that spending has been flat over last year at least until October. This despite the fact that a surge of liquidity in the markets has permitted the government to borrow quite comfortably.

The implications of restrained spending are not entirely clear yet. On the one hand, it is true that the economy seems to be recovering in sync with the easing of restrictions. So it could be argued that activity is recovering on its steam and didn’t need government support.

But economists worry that the scars of low government spending will show up later. The pain across the informal economy and the small business economy is not showing up in the frequently tracked data. If there are large salary and job losses among smaller business, as many believe there are, then after an initial boost, consumption growth will stagnate at lower levels.

As such, the jury is still out on whether the government did the right thing in staying tight-fisted while keeping an eye on already soaring levels of debt-to-GDP, which could be upwards of 85% this year. Or if there will be a steep price to pay for the fiscal conservatism.

Corporate Debt Troubles Did Not Worsen

When the crisis was hit, it seemed like an extension of the bad loan pain that Indian lenders had been facing was inevitable. As a buffer, the Reserve Bank of India went back to permitting one-time restructuring without a downgrade to the bad loan category.

As the deadline of that restructuring window approaches, restructuring sought, at least from large corporates, has been far lower than expected. According to CRISIL, at least 99% of corporates it rates don’t intend to seek restructuring. Two-thirds of these entities were eligible. Small business restructuring requests, while more than those received from large corporates, are also fewer than anticipated. Retail stress, however, is likely to build up.

Counter-Intuitively, large corporate indebtedness eased in the second quarter of the financial year to five-year low, showed data from Credit Suisse.

The share of debt with stressed Indian companies, which have an interest coverage ratio of less than one, has reduced sharply to 35% in the July-September quarter, led lower by the metals and telecom sectors.

We Went Digital...Almost Too Quickly

Going digital has been an aspiration for Indian policymakers in recent years. Heck, we even demonetised 86% of our currency to reach that goal but to no avail.

Covid-19 achieved what demonetisation couldn’t. With most consumers and producers locked down, digital channels became the primary way to making payments. Volumes have surged particularly in retail payments. Between March and November, value of transactions on the most popular Unified Payment Interface went from just over Rs 2 lakh crore to Rs 3.9 lakh crore.

The surge has been so quick that legacy bank infrastructure has been struggling to keep up.

The bad news is that the initial boost in digital payments didn’t actually take away cash. The precautionary demand for cash meant that currency in circulation also surged along with digital payments. The eventual trend will be get clearer as the economy settles back into normal.

Crypto Went Mainstream

Finally, a global trend that gained a surprising amount of currency this year was the main-streaming of cyrptocurrencies.

Amid the volatile global markets, cryptocurrencies like Bitcoin showed surprisingly stable gains. More importantly, you saw large established payment firms become more accepting of crypto.

By July, Visa and Mastercard had announced that they were extending their cryptocurrency partnerships. In October, Paypal allowed buying, selling and spending of cryptocurrencies through its network. In December, Singapore’s DBS Bank said it would set up an exchange for digital assets, including cyrptocurrencies.

India has been woefully behind in the changing attitude to cyrptocurrencies. The government and the RBI are still to finalise their approach on whether to regulate or ban these. A choice in favor of the latter will seem completely out of sync with the direction the world is moving in.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.

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