India's Medium-Term Growth Will Slow to around 6.5% after Initial Rebound: Fitch
The Indian economy will suffer lasting damage from the coronavirus crisis and after an initial strong rebound in FY21-22, the fiscal year ending March 2022, growth will slow to around 6.5% a year over FY22-23 to FY25-26. A combination of supply-side scarring and demand-side constraints - such as the weak state of the financial sector - will keep the level of GDP well below its pre-pandemic path, say Fitch Ratings.
According to the ratings agency, India's coronavirus-induced recession has been among the most severe in the world, amid a stringent lock-down and limited direct fiscal support. "... the current recession will leave lasting scars," Fitch says, adding, "We think the crisis will mean lower investment growth for some years. Slower capital accumulation will be the main source of weaker supply-side growth. Investment demand will be dragged down by the need to repair balance sheets and firm closures. Firms have received limited direct fiscal support, with the overall fiscal stance eased by only a little. Constrained credit supply amid a fragile financial system is another headwind to investment. Banks entered the crisis already fragile, hampered by a misallocation of credit."
According to the rating agency, the Indian economy is now in a recovery phase that will be further supported by the rollout of vaccines in the next months and it expects gross domestic product (GDP) to expand by 11.0% in FY21-22 after falling by 9.4% in FY20-21.
India's GDP growth has been buoyed by high rates of investment historically, the ratings agency says, adding rapid capital accumulation over the last 15 years has boosted labour productivity growth. "Growth in GDP per capita has been faster than most other large emerging markets (EMs), though it has lagged China."
"India’s slower rate of 'catch-up' with advanced economies than China reflects weaker total factor productivity (TFP) growth. This may be related to factors constraining the quality of investment and hampering progress in developing a large manufacturing export base. Nevertheless, there is some evidence of improvement in TFP performance over the last five to seven years," it added.
However, Fitch says it expects the medium-term recovery to be slow. "Supply-side potential growth will be reduced by a slowdown in the rate of capital accumulation - investment has recently fallen sharply and is likely to see only a subdued recovery. This will weigh on labour productivity and our projection of supply-side potential GDP growth for the six-year period FY21 to FY26 has been lowered to 5.1% p.a. compared to our pre-pandemic projection of 7% per annum," it added.
Fitch's historical analysis of India's growth performance highlights the key role played by a high investment rate in driving growth in labour productivity and GDP per capita over the past 15 years.
But it shows that the investment has fallen sharply over the past year and the need to repair corporate balance sheets and firm closures will weigh on the pace of recovery.
The rating agency says, "Constrained credit supply amid a fragile financial system is another headwind for investment. The banking sector entered the crisis with generally weak asset quality and limited capital buffers. Appetite for lending will be subdued, particularly as credit-guarantee and forbearance measures rolled out in the crisis start to be unwound."
"The economy should be able to grow somewhat faster than estimated supply-side potential over the medium term following the unprecedented downturn in FY21. But our projection for the medium-term recovery path - at around 6.5% p.a. over FY23 to FY26 - would leave GDP well below its pre-pandemic trend," it concluded.