Worry about middle India

Business Standard, 10 January 2022

The Indian "K-shaped recovery" involves booming stock prices and a happy world of startups, alongside difficulties in most households. Middle India has suffered from numerous shocks in recent years. The recovery after the second wave did poorly from September 2021 onwards, and then Omicron came along. Sustained economic stress has led to drawing down assets and increasing borrowing. This will hamper the demand side of the economy, particularly in the product categories where many deciles of the income distribution are important customers.

The right way to think about the state of the economy today is to compare against pre-pandemic conditions, and not engage in year-on-year comparisons. On many measures, Jan 2020 to Jan 2022 is a period of retreat. The market capitalisation of the broad equity market is at an astonishing Rs.266 trillion. But alongside this, many large private firms with high valuations are cautious in their investment projects, which would tend to suggest a sombre outlook for growth in operating profit.

There are important difficulties in middle India, as the widely used phrase `K-shaped recovery' suggests. The number of persons working has been broadly stable from 2015 onwards, while the number of persons of working age has grown steadily. A large swathe of households has lower income when compared with pre-pandemic conditions.

Middle India is the world of small businesses and people without formal sector jobs. It has experienced a succession of shocks, from demonetisation to GST to the pandemic. By now, there is reduced financial depth, as consumption has been smoothed by selling assets and by borrowing. For many households, now there is a more precarious economic/financial environment. This will manifest itself in the tightening of belts.

In macroeconomics, everything is inter-connected. The fortunes of many large listed companies depend on the optimism and spending patterns of hundreds of millions of households in middle India. We saw this play out with demonetisation. At first, the formal sector flourished, because big firms gained market share and pricing power at the expense of SMEs when faced with demonetisation. But with a lag, the difficulties of middle India came back to influence the growth and profitability of the big firms through slow growth of sales.

Some hints of this problem are visible in the data today. As an example, consider sales of two wheelers. In the quarter ended September 2019, sales were 5.59 million and two years later this was at 5.22 million, which is 6.6% lower. The difficulties of middle India have fed back into the large firms making two wheelers and further on to their component makers.

With consumer sentiment and with labour market conditions, there was a rapid recovery after the lockdowns of March and April 2020. A similar recovery has not come about after the second wave. There was a short recovery until August 2021, but from September to December 2021 there was stagnation. The Omicron variant is likely to make things worse for a month or three of 2022. Putting these pieces together, there may be a problem of demand shortfall from middle India in 2022. This will be a factor influencing some industries (e.g. biscuits, two wheelers) more than others (e.g. cars).

The media is carrying many happy stories about the revolution of venture capital financing, startups, and successful exits including through IPOs. This is undoubtedly happy news for a subset of the Indian population. But the magnitudes are unlikely to matter on the scale of the economy. For example, if we think there are 50,000 startups with an average employment of 10 each, this adds up to 0.5 million workers, which is a tiny number compared with the overall 410 million workers in India. Similarly, the equity capital raised through listed securities by all firms (large or small) in 2021, at Rs.2.65 trillion, is small change when compared with the magnitudes of the Indian economy.

If middle India is indeed facing these difficulties, there are two dimensions of concern which we need to think about for 2022. The first lies in the financial sector. A lot of households have borrowed in order to smooth consumption through the shocks of the recent years, and had a more rosy picture of prospects for their personal economic recovery at the time that they borrowed. These households are facing tough loan recovery procedures, and have no recourse to individual insolvency mechanisms. These households may pull back on consumption the most, and they may default on their debt.

In the recent decade, a large class of people in India have a sustained disengagement from the labour market, and live a life of `bread and circuses'. There have been concerns about the loss of morale, and vulnerability to political radicalisation, of these individuals. This threat of political radicalisation may be even greater with borrower households who are facing balance sheet stress.

The second dimension of concern lies in real sector investment. The firms that sell to middle India will worry about the prospects for demand growth in 2022 and 2023. Difficulties in their demand buoyancy, potentially accompanied by slight capacity expansion through commissioning of investment projects which had been initiated before the pandemic, can generate pressure on margins. This prospect of reduced margins and weak demand growth can induce weaker investment by these firms, thus influencing the overall demand conditions in the economy.

The stock market is very important. A firm with a high price-to-book ratio is getting a direct plea from the stock market encouraging its investment plans, with the promise of wealth creation when book value goes up. High stock prices are an important positive about the economy today. Nifty is up 110% over the last 5 years, while the Shanghai Composite Index is up 20%; this is surely a vote of confidence on India, and a contrast with China's sulking retreat into the China model of nationalism, xenophobia and central planning. But we should worry more about middle India, as everything is inter-connected in macroeconomics.

Back up to Ajay Shah's 2022 media page
Back up to Ajay Shah's home page