India: Brutal second wave to put a dent in 2021 recovery
India is currently in the throes of a massive second wave of Covid: alarming headline figures are likely an understatement of the true rise in cases. The pace of increase in cases has overwhelmed the healthcare system and forced the hand of state governments to introduce lockdowns.
Given the recent communication by Prime Minister Modi, we think a national lockdown remains the central government’s least preferred option. Instead, state-led restrictions will be at the forefront of controlling the virus. The central government aims to ramp up treatment and vaccinations, but neither of these are credible solutions in the near-term.
Six states accounting for 1/3rd of Indian GDP have announced either state-wide or targeted localized lockdowns. The severe nature of the second wave and the restrictions put in place to date is already weighing on mobility – even in regions which have not imposed restrictions, individuals and firms appear to be reacting. Indeed, we think mobility will decrease further in the coming weeks as further lockdowns are likely and people voluntarily choose to restrict movement.
We expect the main impact of this second wave to show up in Q2’2021 data. Conditioning on the current level of restrictions and the fact that the manufacturing sector has been allowed to remain open, we expect the magnitude will not be of the same scale as the 25% q/q contraction in Q2’2020.
Ultimately the extent of the damage to the economy will depend on the measures put in place to bring cases under control and alleviate pressure on the healthcare system. At this stage any nowcast is highly uncertain, but our best guess is for a contraction in the range of 5-7% q/q.
Some pass through into inflation is also to be expected. Perishable items and items with cross-India supply chains could face some upward pressure as lockdowns are imposed in different states. Upward pressure on headline inflation is unlikely to materially influence RBI policy.
The RBI’s approach to maintaining ample liquidity and providing targeted support last year worked well. To that extent we expect the announcement made by Governor Das today to have a positive effect on sentiment as well limit the financial fallout from the second wave. Within the support measures announced by Governor Das today we think the credit provision to the healthcare sector as well SME’s is well timed and targeted.
Fiscal policy had already become more supportive ahead of the Covid resurgence, but there is little sign so far that it will be expanded further to cushion the shock. The government’s balance sheet is already quite stretched and policy announcements do not suggest an easing. However, front loading expenditure in Q2 and Q3 could help buffer the contraction.
The fallout from lower growth in India will have limited direct impact on its major trading partners. It will however disrupt the export of vaccines from India to other developing countries and the Covax initiative. Turning inward will help India achieve herd immunity more quickly, but this correspondingly implies a slower path of vaccination for other countries, a risk that is amplified if the recent surge in India is sustained.
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