India’s sprinting recovery faces these final hurdles ahead

Both the government and the Reserve Bank of India (RBI) have provided enabling conditions for the recovery to gain traction. Fiscal measures such as production linked incentive schemes, larger capital outlay for FY22, credit guarantee schemes, among others, have had begun to have an impact as is evident from higher credit offtake by small businesses and increase in investments. Real interest rates are low and the RBI has promised to maintain surplus liquidity.

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So what could go wrong?

Here are some of the risks that analysts have flagged which have the potential to slowdown if not derail growth recovery:

Riding the wave

There has been a resurgence in fresh infections of covid-19 across the country recently. This has fanned fears of a second wave and the likelihood of lockdowns being imposed again. Already, select districts across states have been put under lockdown by respective administrations. A surge in cases in big cities has been worrying state governments. While lockdowns may not be stringent as in the past, they do restrict mobility of goods and people.

"The state government in Maharashtra has announced restrictions to mobility, including localised lockdowns, which along with individual risk aversion could stall NIBRI’s return to prepandemic normal," wrote analysts at Nomura Financial Advisory and Securities (India) Pvt Ltd. NIBRI is a business resumption index tracked by the brokerage firm.

Wounded Banks

Businesses hit by the pandemic have been able to access funds thanks to the RBI’s liquidity infusion and the government steps to take care of credit risk. Indian banks have been at the forefront of lending to small businesses but not until the government took the credit risk away from them. But bank balance sheets are still encumbered with legacy bad assets. Public sector banks that account for more than half the system’s credit continue to see capital flowing towards provisions rather than growth.

Pranjul Bhandari, chief India economist at HSBC Securities and Capital Markets (India) Private Limited, warns that banks may see resurgence in bad loans in the coming years. Given that insolvency code remains suspended, there is no recourse for banks to recover money. Once all forms of forbearance are over, borrowers may show their true stress. “While capital buffers at banks have improved, there is uncertainty around the evolution of NPLs," she wrote in a note.

Fiscal Squeeze

Having given a not-so-inspiring stimulus in FY21, the Union Budget has promised to deliver on capital expenditure in FY22 to ensure that economic recovery is sustainable. Capital spending has a higher growth multiplier effect and public spending results in crowding-in of private capex. But although the Centre is poised to increase its capital outlay, state governments are hamstrung.

States do the heavy lifting in actual capital spending and weak state finances are an impediment. An encouraging sign has been that 18 states reported a 3.1% growth in overall spending in the December quarter compared to a record 11.1% decline in September quarter, according to analysts at Motilal Oswal Financial Services Ltd. That said, state revenues are yet to show reasonable growth and in the face of weak revenues a sustained expenditure trajectory is unlikely.

Bhandari of HSBC believes that both states and central government revenues would depend on how fast the economy recovers.

The government will release third quarter gross domestic product (GDP) growth numbers later this week. The economy is expected to have grown by 0.5% after two consecutive quarters of contraction. For GDP growth to recover fully, fixing these impediments is key.