With the deadly second wave of Covid-19 spreading throughout the country, the likelihood of a quick economic recovery as expected by the government, which until recently was insisting on achieving a 7 percent growth target, is almost nil. Economic scarring, or the persistent effect of the pandemic on economic activities, has deepened, and already weak economic fundamentals have exacerbated.

This is reflected in the recent national account data released by the Central Bureau of Statistics (CBS), which projected the country’s GDP to grow at 4 percent in 2020-21, up from a 2.1 percent contraction in 2019-20. Given the assumption behind the estimation and the rapid spread of Covid-19, CBS’s growth projection will most likely be an overestimation. The onus to stabilise economic activities and chart out a viable recovery path is now on the government, as consumption demand and private investment remain subdued.

Slower than expected

The bureau projected agricultural, industrial and services output to grow at 2.6 percent, 5 percent and 4.4 percent respectively in 2020-21. This is a reversal from industrial and services sector contraction last year. These projections are based on eight to nine months of data and the assumption that economic activities will gradually pick up from mid-May 2021 as lockdowns ease and accommodation and food service activities (basically, travel and tourism) quickly bounce back.

Agricultural output, especially paddy, is projected to increase due to a favourable monsoon and a surge in agricultural labour, thanks to reverse migration from cities due to the lockdowns. Within the industry sector, electricity, gas and utility supplies are projected to increase by 7.7 percent, substantially down from the 25.6 percent growth in 2019-20 as new hydroelectricity addition to the national grid slowed down. This is partly due to the repeated delay in the completion of the Upper Tamakoshi project.

Mining and quarrying activities are estimated to grow at 7.5 percent, up from 2.2 percent contraction in 2019-20 as mining and quarrying of stones, sand, soil and concrete affected by the lockdowns were allowed to operate after the substantial easing of lockdown restrictions in September 2020. Moreover, a boost in the construction of housing and infrastructure projects is expected to positively affect mining and quarrying activities.

Construction activities are projected to increase by 5.6 percent, up from a 5 percent contraction in 2019-20 as household, commercial and infrastructure projects pick up pace after a slack last year. Manufacturing activities, which are projected to increase by 3.9 percent from 8.6 percent contraction last year, continue to be affected by lockdowns and containment measures in addition to low private sector investment and high costs of production. Manufacturing activities might actually remain subdued at least till the medium-term.

Within the service sector, which accounts for about 54 percent of GDP, there is an expectation that high-contact activities will recover quickly. Wholesale and retail trade, transport and storage, and accommodation and food service activities are projected to increase by a rate of over 5 percent. These activities contracted the most last year. The CBS is especially bullish about the resumption of domestic tourism activities starting this month and is expecting accommodation and food service activities to grow by 11.2 percent, the highest amongst all subsectors.

Stabilisation and recovery

The latest growth projections indicate an economy that was losing steam even before the pandemic. Growth was already decreasing since a high of 9 percent in 2016-17, which itself was largely due to base effect, as economic activities came to almost a standstill in 2015-16 owing to crippling border blockade. The base effect refers to the tendency of achieving an arithmetically high rate of growth when starting from a very low base. This time, in addition to weak economic fundamentals and unrealised political and peace dividends, the inadequate infrastructure provision and a collapsed healthcare sector have laid bare economic and social vulnerabilities. Economic scarring is going to be deep, due to diminishing labour force participation, impending household and firm bankruptcies, and disruption of production networks both domestically and externally.

Given the lack of preparedness for a surge in cases (due to the overwhelmed healthcare system and a lack of adequate fiscal and monetary lifelines during the second wave) disruptions to labour, capital and product mobility, supplies disruptions, and political instability, economic activities may not actually recover beyond the base effect in 2020-21. Capacity utilisation of firms will be hit due to lockdowns, and supplies and market uncertainties will dissuade private investment, which is also being affected by political instability, bureaucratic hassles, bad governance, and low public capital spending.

A lack of employment opportunities both in the formal and informal sectors will curtail household income and consumption. Similarly, the inability of the government to boost capital spending will also affect mining and quarrying, and construction activities—thus impacting industrial growth. Manufacturing and exports are not expected to recover anytime soon. Against this backdrop and that lockdowns happened in the third and fourth quarters—the time when most economic activities take place—the economy might hardly grow. Or, it may even contract for the second year in a row.

Unfortunately, there is hardly any fiscal space left to launch temporary social protection schemes and relief measures targeted at households and businesses because the fiscal deficit is projected to hit around 6-7 percent of GDP in 2020-21. If the government allocates funds for new elections, then it might lead to a decrease in public spending as revenue mobilisation slows down in tandem with the expected decline or muted growth in economic activities.

It might also affect the banking sector, which might see demand for new credit decrease after a slight increase in the first half of the year. Firm bankruptcies due to cashflow problems and a subsequent rise in non-performing assets are real possibilities, particularly after the regulatory forbearance on loan payments is lifted and refinancing opportunities dry up. Micro, small and medium enterprises, which do not have much cash reserves to cushion against negative shocks, will bear the brunt of the crisis. It means economic and employment outlook over the medium-term do not look promising.

The upcoming budget needs to squarely focus on relief and recovery measures, and scaling up investment in the healthcare system. Given the tight fiscal conditions, only projects that can be completed in the next two to three years should be prioritised for capital investment. Furthermore, operations and maintenance of existing assets should be prioritised so that the impact on employment generation and growth is quick. This requires active reprioritisation and reallocation of spending. All expenses related to the pandemic should be listed as a separate heading in the budget so that this could be mobilised quickly and accounted for properly. This is the time for economic and livelihoods stabilisation measures. Economic recovery strategy anchored on medium-term expenditure and revenue frameworks should be included in subsequent budgets.