Lower consumption at the bottom of the pyramid will affect growth
Economic activity is recovering, with a decline in new Covid-19 cases and an increase in public mobility. Economists believe that the impact of the second wave on output has been less severe than the first, and is expected to remain limited to the first quarter of the current fiscal year. Although the focus usually is on the headline gross domestic product (GDP) numbers, the pandemic has had a material impact on the household balance sheet. A delayed economic recovery will prolong the pain for households. While the actual impact on individual finances will be known after a significant lag, incoming data and studies give some idea as to how different segments are dealing with the pandemic.
The Reserve Bank of India (RBI) released the preliminary estimates of household financial savings for the third quarter of 2020-21 on Wednesday. The net financial savings expectedly declined from a high of 21 per cent of GDP in the first quarter to 8.2 per cent in the third quarter. Both precautionary savings because of the pandemic-related uncertainties and forced savings due to a stringent lockdown seem to have pushed household financial savings in the first half of the last fiscal year. As the economy opened up, financial savings came back to a more normal level. Interestingly, mutual fund investment in the third quarter was at 1.2 per cent of GDP, compared to the annual level of 0.2 per cent in 2019-20. It appears that some households increased investment in mutual funds because bank deposits were offering negative real returns.
However, it’s important to note that the aggregate financial savings data do not say much about the impact of the Covid-related shock on different segments of households. A new National Bureau of Economic Research working paper, “Explaining the Income and Consumption Effects of COVID in India”, offers useful insights in this context. Using the Centre for Monitoring Indian Economy’s Consumer Pyramids Household Survey data, the paper shows a large drop in incomes due to Covid through December 2020. It notes that income for salaried workers fell by 35 per cent, while the decline for daily labourers was to the tune of 75 per cent. Among the salaried class, white-collar workers were the least affected. Daily labourers, including those in the agriculture sector, were hit significantly harder. The paper also notes that consumption fell less than income with a clear distinction between essential and non-essential items. All this again shows that households at the bottom of the income pyramid suffered the most. A recent study by Azim Premji University found that an additional 230 million individuals fell below the poverty line because of the Covid shock.
The second wave would have further damaged the household balance sheet. As a result, a large number of households would first want to repair their balance sheet, which can affect consumption and overall economic recovery. At another level, the decline in household financial savings from last year’s high will make financing the fiscal deficit more difficult. Since the general government budget deficit is expected to remain elevated in the near term, a sustained RBI support can increase inflation risks. This will again affect the lower-income groups. Thus, the health of the Indian household balance sheet will depend on the nature and pace of economic recovery.