India: Second wave and vacci”notion”

The GDP print came out on February 26 and showed positive y/y growth of 0.4%. This puts India on the list of only a few economies that were able to show y/y growth. Two of the main drivers are the 2.6% y/y growth in capital investments and a rebound in private consumption from -11.3% y/y in Q3 to -2.4% y/y in Q4.

Although these positive numbers appear attractive, we might need to temper expectations for the first half of calendar year 2021. Containing Covid-19 is vital to full economic recovery, and the recent rise in daily corona cases in India indicates that the pandemic is far from beaten.

In recent weeks the number of new Covid-19 cases has increased dramatically (Figure 1). One possible reason for this new surge is the optimism surrounding the availability of vaccines, which may have caused people to lower their guard with regard to the spread of the virus. This is also reflected in the sudden rise in mobility from mid-January, as can be observed in Figure 2 which shows the activity in transit stations and workplaces relative to the pre-Covid baseline. However, the upward trend seems to have flattened in recent days. It will be interesting to follow this development in the coming weeks, as the steepness of the curve should sound the alarm for people to limit their movements to prevent the virus from spreading. If not, new restrictions could be imposed to contain the spread. Whether restrictions are voluntary or mandatory, they will hamper economic growth in March and April.

Meanwhile the vaccination program is continuing at a steady pace. Currently 2.2 million people per day are being inoculated which, at first sight, seems an impressive number. However, if we assume that every individual needs two shots, this pace means that at the end of the year only 670 million people (or 25% of the population) will have received the full inoculation. Unlike many other countries, the availability of vaccines is not the problem. India has secured vaccine doses contracts for more than 85% of the population, way more than regional peers. However, many people seem reluctant to get the vaccines, with most locations administering less than 50% of capacity. In an attempt to increase the daily pace of vaccination, the government announced that everyone above the age of 45 is eligible for vaccination from April 1. An acceleration in the vaccination program and improved virus resistance, locally and globally, will increase (international) mobility, which will enable the rebound of the service-oriented sectors and foster the path to full economic recovery.

In February CPI inflation increased to 5% after reaching a low of 4.1% in January, which was the lowest rate since September 2019. Our expectation is that inflation will remain elevated through 2021. The first signs of rising fuel costs were already apparent in February (Figure 4), and with the global economy continuing to recover we do not expect commodity prices to come down anytime soon. In addition, we expect private consumption to accelerate in the second half of the year, which opens a window for manufacturers to pass on increased production costs (as a result of higher input prices) to consumers, increasing core inflation.

As a result, we expect the RBI to maintain its policy rate at the current level of 4%. This forecast is based on the inflation expectations as described earlier, and on the notion that the government of India is already stimulating the economy through additional fiscal policy as announced in the FY22 budget. These factors would allow the RBI to take the back seat with regard to additional monetary stimulus, especially as additional stimulus raises the risk of even higher inflation. Other stimulus, such as supporting government borrowing by monetary financing, would not be wise at this stage. As argued before, we strongly advise against monetary finance, which could have dire consequences in terms of higher inflation and/or a weakening external position.