The Indian economy has bounced back from the fall it had witnessed due to the COVID-19 pandemic and the lockdown after that, but it would take structural reforms for the nation's GDP to grow beyond a particular level, said UBS in its Global Economics & Markets Outlook 2021-2022.

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The Indian economy would have lost close to Rs20 trillion ($265 billion or 10.5% of its GDP between April and September 2020 due to the pandemic and the following mobility restrictions. That said, economic activity appears to be returning gradually to pre-COVID levels, as reflected in various high-frequency indicators.

According to official data on Friday, India's GDP contracted 7.5% in the quarter to September, showing some signs of a pick-up after easing pandemic restrictions that triggered a record contraction in the previous quarter.

The Q2 GDP of 2020-21 is estimated at Rs 33.14 lakh crore, as against Rs 35.84 lakh crore in Q2 of 2019-20, showing a contraction of 7.5% as compared to 4.4% growth in Q2 2019-20.

In the near term, UBS believes that the biggest challenge for India will be to get consumption back on track on a sustainable basis as virus fear, income uncertainty (job losses and/or reduced income levels), and a conservative policy response could weigh.

The balance sheet concerns facing the economic agents (government, households, and financial sector) have become amplified due to the COVID-19 shock, in its view.

"In our base case, we expect India's real GDP to contract 10.5% in FY21 (versus +4.2%YoY in FY20). Going forward, we expect India's real GDP growth to rebound to +10%YoY in FY22. Our baseline forecasts assume that consumption growth will normalise (though continue to remain below trend) as both employment and income growth recover on normalisation in economic activity and hopes of pandemic coming under control after a vaccine is available," said the report.

Even as private corporate capex recovery takes some time to recover, UBS believes policy measures to boost public capex, especially infrastructure spending, could be the next catalyst to watch out for.

Exports also could get some support as global growth rebounds from the recession this year.

UBS estimates India's growth should stabilise close to a potential at 6.2%YoY in FY23 after the post-Covid rebound in FY22 as gains from improved reform momentum begin to reflect higher productivity and output.

The macro-dynamics crucially hinge on India's ability to maintain and even boost its underlying potential growth.

According to UBS estimate, India's potential growth slowed to 5.75- 6.25% (from 7.1% estimated in 2017) due to a longer-than-expected disruption caused by the pandemic, balance sheet concerns faced by economic agents, and limited fiscal capacity to support growth.

UBS expects the renewed focus on productivity-enhancing reforms and investments could help support India's medium-term growth outlook.

Over the last few months, the government announced a few long-standing reforms related to the labour, agriculture, measures to boost manufacturing and infrastructure spending, to optimise the golden opportunity to gain share in global supply chain shifts.

The policy bias seems to be changing from repair to growth. Looking at macro stability risks, UBS believes India is doing well in terms of external vulnerability indicators. As the economy recovers from the COVID-19 shock, it expects more robust domestic demand to reverse the current account balance's sudden gains.

"Our productivity-based fair value model for the INR indicates the currency is currently trading past its equilibrium value. We expect USD/INR to remain largely range-bound in the 73-78 range in FY22-23," said the report.

Notwithstanding the elevated inflationary pressures, UBS expects average CPI inflation to remain within the RBI's medium-term target (4+/-2%) in FY22-23, ensuring policy rates stay lower for longer.

Lastly, UBS believes the rising fiscal deficit this year on COVID-19 shock could lead to high public debt to GDP in India, thus raising debt sustainability concerns. A greater focus on privatisation could be explored to help keep a check on the fiscal slippages without constraining government spending.

Key Highlights:  

  • Economic activity gradually normalising as mobility restrictions are getting relaxed.

  • Growth to rebound in FY22 as consumption normalises and global growth recovers

  • There is a golden opportunity available for India to gain market share due to global supply chain shifts.

  • INR is currently trading past its equilibrium value against the USD

  • Accommodative monetary policy and government spending push to help support growth