View: A 'consumption gap' will be the lasting legacy of Covid 19 - Economic Times

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There is a weak spot in India's impressive economic recovery from the second pandemic wave. Private consumption, the largest contributor to GDP, is unlikely to return to its pre-pandemic trend path, perhaps for a very long time. There are four telling reasons why.

First, India's labour market recovery has been uneven and incomplete. The easing of the all-India unemployment rate to the pre-pandemic 7-7.5% is only partially assuring if we consider that labour force participation has also declined by nearly two percentage points. The size of job-seeking or earning population has shrunk. And even if those who dropped out return to the job market, the unemployment rate may still increase.

Rural India, at first, seemed to fare better than urban areas. The onset of kharif (monsoon) crop season around June fuelled the demand for agricultural labour, which concealed the poor wage growth and lack of jobs in non-agricultural sector. Further, with 'reverse migration' of low-skilled labour from urban to rural areas, disguised unemployment on the farms likely increased as well, dampening agricultural productivity and per-capita incomes. Now that kharif is drawing to a close, the rural unemployment rate is rising once again.

In urban India, a harsher slowdown in services translated into larger wage and job losses. The salaried younger class, especially women, were worst impacted. Thankfully, with the economy reopening, the urban unemployment rate has been easing. But it still masks falling incomes and labour force participation. The urban labour market may continue to face challenges to the extent the negative output gap in the service sector may take longer to close.

Second, the Covid-19 pandemic has widened income and wealth inequalities that will weigh on consumption. A larger economic shock rippling through the informal sector has subdued the demand for labour in the informal jobs market, which employs 80% of India's workforce. In contrast, strong corporate earnings and 'forced formalisation' of the economy during the pandemic mean the demand for labour in the formal jobs market will revive much faster. Several recent corporate surveys on hiring intentions and wage growth reflect such optimism.

Increased wealth inequality, as anywhere else in the world, is an outcome of the monetary policy response to the pandemic. Amid flush liquidity and interest rates hitting the floor, household interest income from bank deposits took a hit. Bank deposits comprise more than half of household financial assets in India. In contrast, stocks that represent only 10% and are concentrated among richer classes, have seen high returns.

Third, the most rapid phase of pent-up demand is behind us as the savings ammo is depleting. India's economic recovery after the first wave was funded by household savings that touched 21% of GDP in Q2 2020. By Q4, the household saving rate had already fallen to 8.2% of GDP, closer to its long-term average. While data beyond 2020 are not yet available, it is likely that over 2021, the household savings rate dropped further due to the second pandemic wave. India's reduced gold demand, rising personal loans against jewellery and decelerating aggregate bank deposit growth are, perhaps, some important markers of such stress.

Finally, India's fiscal policy response to the pandemic, especially on account of direct support to households, has been relatively weak. In terms of additional spending or foregone revenues, the International Monetary Fund (IMF) pegs India's fiscal support at nearly 5% of GDP, lower than many other Asian economies. This means the fiscal impulse to private consumption is unlikely to be strong enough to fill the gap.

If India's real private consumption were to reach its pre-pandemic trend path, it probably needs to grow more than 9% every fiscal year till FY2026. Amid a lack of strong income-drivers and deeper inequities, such a feat looks impossible. A 'consumption gap' will, therefore, be a lasting legacy of the pandemic.

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View: A 'consumption gap' will be the lasting legacy of Covid 19 - Economic Times
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