Emerging

Structural reforms instead of fiscal support

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Eco Emerging // 1 quarter 2021  
economic-research.bnpparibas.com  
5
INDIA  
STRUCTURAL REFORMS INSTEAD OF FISCAL SUPPORT  
The economy has rebounded strongly since July, driven by the recovery in industry, which then spread to the services  
sector starting in October. Although the recovery still seems to be fragile, the central bank has raised its growth  
forecast for fiscal year 2020/2021 to -7.5%. Fiscal year 2021/2022 is expected to see a major automatic rebound in  
growth. Lacking the means to support growth through a fiscal stimulus package, the government has set out to create  
a more propitious environment for investment that would enable medium-term growth to return to a pace of about  
7
%. The latest reforms are working in this direction. Yet passing reform measures does not guarantee that they will  
be implemented, much less that they will be successful.  
A FRAGILE REBOUND  
In the second quarter (July-September 2020) of the fiscal year that will  
end on 31 March 2021 (FY2020/2021), India’s GDP growth contracted  
FORECASTS  
only” 7.5% year-on-year (y/y), after contracting 23.9% y/y in the  
2
019  
2020e  
2021e  
2022e  
previous quarter. Business accelerated in agriculture (+1.4% y/y) and  
to a lesser extent in industry (+0.6% y/y), but continued to contract in  
services (-11.4% y/y). At the end of September 2020, economic activity  
was still 9% short of the figure reported for full-year 2019/2020.  
At the beginning of fiscal Q3, the recovery began to expand into the  
services sector. Activity accelerated rapidly in industry in October 2020,  
even though November’s industrial production was still 6% below the  
year-end 2019 level. Demand for electrical power rose above the  
Real GDP growth(1) (%)  
4.2  
-11.4  
5.8  
11.6  
4.3  
5.0  
3.8  
Inflation (1) (CPI, year average, %)  
General Gov. Balance(1) / GDP (%)  
General Gov. Debt(1)/ GDP (%)  
Current account balance(1) / GDP (%)  
External debt(1)/ GDP (%)  
4.8  
-7.3  
72.2  
-0.9  
19.9  
457  
7.7  
-13.2  
89.8  
0.3  
-11.0  
90.1  
-0.9  
21.0  
590  
9.1  
-9.0  
90.3  
-2.0  
20.5  
620  
9.2  
21.5  
541  
Forex reserves (USD bn)  
2
019 level. The unemployment rate continued to decline to 6.5%, after  
Forex reserves, in months of imports  
Exchange rate USDINR (year end)  
11.0  
73.1  
peaking at 23.5% last April. Lastly, VAT revenues increased by nearly  
71.3  
73.4  
73.9  
1
5% compared to the same period last year, after several months of  
decline.  
(1) Fiscal year from April 1st of year n to March 31st of year n+1  
e: ESTIMATE & FORECASTS  
TABLE 1  
November indicators suggest, however, that the recovery is still fragile,  
for both households and corporates, even though India has not yet  
been hit by a second wave of Covid-19. Although business confidence  
indexes in both industry and the services sector have held above the  
SOURCE: BNP PARIBAS ECONOMIC RESEARCH  
INDUSTRIAL OUTPUT  
5
0 threshold (which indicates economic expansion), they declined  
Industrial production  
Durable consumer goods  
Capital goods  
slightly in services. Bank credit to industry also contracted for the  
second consecutive month (-0.7% y/y).  
6 01 00 = Dec 2019  
40  
1
1
The household confidence index rebounded slightly in November 2020  
but remains far below pre-crisis levels. The unemployment rate is now  
close to the level that prevailed in late 2019, but the labour market  
participation rate is still 2 points below pre-crisis levels. Employment  
is still sluggish in the construction, hotel & restaurant, tourism and  
textile sectors. Lastly, there seems to be a dichotomy between urban  
and rural household consumption. Motor vehicle sales (cars and two  
wheelers) declined in November after rising for two months. In rural  
areas, in contrast, household consumption seems to be robust, as  
illustrated by the sharp increase in tractor sales, buoyed by a bumper  
harvest and an increase in rural wages (between 8% and 10%) as part  
of the Mahatma Gandhi National Rural Employment Generation Act.  
120  
100  
80  
6
0
0
4
20  
0
2015  
2016  
2017  
2018  
2019  
2020  
SOURCE: CEIC  
CHART 1  
In full-year 2020/2021, the IMF and the World Bank are forecasting  
a contraction of about 10% of GDP. The World Bank fears a sharp  
increase in the poverty rate because 90% of workers do not benefit  
from sufficient social protections.  
MEASURES TO STIMULATE MEDIUM-TERM GROWTH  
Fiscal year 2021/22 should see a major, automatic rebound in growth.  
Household consumption is expected to accelerate, bolstered by the winding India’s economy should be in a position to absorb the shock of  
down of the pandemic and efforts to vaccinate the population, which should 2020/2021. Though fragile, the banking and financial sector should be  
begin in mid-January. Business is also expected to rebound progressively able to support the expected increase in non-performing loans, even  
among small and mid-sized enterprises. Although we cannot exclude the though the government may have to make more capital injections.  
risk of a new wave of the virus, it does not seem likely that the government Although the fiscal deficit is rising, refinancing risks are still mild.  
would impose a lockdown as strict as the one in March-April 2020.  
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Eco Emerging // 1 quarter 2021  
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Looking beyond 2021, in contrast, the situation could deteriorate if GDP  
growth fails to exceed 5%, at a time when fiscal leeway will still be  
tight.  
NON-PERFORMING LOANS ARE STILL LIMITED  
This is why the N. Modi government has been striving to correct the  
slowdown in growth since 2019. It is still working towards its goal  
of becoming an industrial power. Consequently, although it cannot  
set up a fiscal programme to stimulate growth in the short term, the  
government has adopted new reforms to stimulate medium-term  
growth.  
The reforms adopted in 2019 and pursued through fall 2020 aim to  
create a more favourable environment for private investment (both  
domestic and non-resident) and employment, especially jobs in the  
formal sector. Declining investment was one of the factors behind the  
slowdown in growth reported in recent years. The investment ratio had  
dropped to only 26.9% before the Covid-19 crisis, compared to 35.8%  
in 2008.  
8 % loans  
6
in public banks Non performing loans in the banking sector  
1
1
14  
1
2
0
8
6
4
2
0
1
0
3-16 09-16 03-17 09-17 03-18 09-18 03-19 09-19 03-20 09-20  
To stimulate domestic and foreign investment, the government  
lowered the corporate tax rate in late 2019 from 30% to 22% (and from  
CHART 2  
SOURCE: RBI  
2
5% to 15% for newly created manufacturing companies). Aligning its  
corporate tax rates with those practised in the other Asian countries  
was a positive move.  
The government also adopted major legislation to ease the restrictions  
hampering the labour market and to encourage the creation of jobs  
in the formal sector. This allows companies to develop more labour-  
intensive activities, much like the model that China followed in the  
the rating agency S&P estimated that the doubtful loan ratio could  
increase by 2 to 3 percentage points to 10-11% by the end of fiscal year  
2
020/2021. In its most recent report on financial stability, the central  
bank estimated that the NPL ratio could reach 13.5% by September  
021 (16.2% among state-owned banks), even under a scenario based  
2
on a strong rebound in growth (from 0% y/y in H2 2020/2021 to 14.2%  
y/y in H1 2021/2022).  
1
980s and 90s, and to increase their participation in global trade  
through labour-intensive assembly work using low-skilled workers.  
Indian banks are better capitalised than they were three years ago. In  
Q3 2020, provisions covered 72.4% of doubtful loans, and the solvency  
ratio for the banking sector as a whole was 15.8%. Yet the state-owned  
banks are still much more fragile than the private banks (their ratio  
was 13.5%). According to the central bank, without capital injections,  
four banks will not be able to meet their equity capital requirements  
by September 2021.  
The central bank considers that the overall solvency ratio could  
decline by 1.6 percentage points to 14% by September 2021. At the  
end of August 2020, Moody’s estimated that the state-owned banks  
would need new capital injections of between INR 1.9 trillion and INR  
To increase productivity in the agricultural sector, the Modi government  
passed three bills in September 2020. The government would allow  
farmers to sell their crops at prices they set with their buyers, without  
using the government as an intermediary (this is now the case for the  
majority of farmers). This reform aims to increase investment and  
productivity in the agricultural sector. Yet it was very poorly received by  
the agricultural world, which feared the elimination of minimum sales  
prices (which are nonetheless guaranteed by the government). After  
several months of protests, the Supreme Court announced on January  
1
2 the suspension of these three bills in order to find a compromise  
between the government and the farmers.  
2
.2 trillion (1% of FY2020 GDP) over the next two years to maintain  
Lastly, the government announced that it intends to privatise all state-  
owned companies in so-called non-strategic sectors, which includes  
rail transport and electrical power companies.  
If all of these reforms were implemented successfully, they could have  
a positive impact on medium-term growth. Yet adopting reforms has  
always been problematic in India, as illustrated by the mixed results of  
the introduction of the Goods and Services Tax (GST) in 2017.  
a provisioning coverage ratio of 70% and to meet their equity capital  
requirements. The state-owned banks are in a more comfortable  
financial situation than they were a few years ago, and the big state-  
owned banks have already launched moves to raise capital. They could  
still benefit from government support, which already injected INR 2.8  
trillion between 2016/2017 and 2019/2020. Yet certain banks might  
be much less inclined to increase their credit offer as long as their  
financial position has not been consolidated, as was the case in 2017-  
BANKING SECTOR: SUPPORTING THE RECOVERY WILL NOT BE 2018.  
EASY  
Completed on 11 January 2021  
After several years of consolidation, India’s banking sector now seems  
to be better positioned to handle a crisis than it was three years ago. On  
the other hand, it might not be solid enough to stimulate the recovery.  
Johanna MELKA  
johanna.melka@bnpparibas.com  
Between March and the end of August 2020, the banks granted a  
6
-month moratorium on debt payments. No loans were recorded as  
non-performing loans. In Q3-2020, despite the contraction in economic  
activity, the non-performing loan ratio continued to decline to 7.5%,  
from a high of 11.5% in Q1 2018. The banking sector did not begin  
to feel the impact of the Covid-19 crisis until Q4 2020. In November,  
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