RaboResearch - Economic Research

The shape of India’s exit from the COVID-19 crisis

Economic Report


Also published on Bloomberg/Quint May 15, 2020

  • As the nationwide lockdown restrictions that started on 24 March are being eased, it is time to think about India’s exit from the COVID-19 crisis
  • A V-shaped recovery is possible if the lockdowns are successful in phasing out the virus, demand picks up rapidly after the lockdown phase and no structural damage is inflicted to the economy
  • There is a chance, however, that India has to impose a social distancing economy in the years to come. Together with subdued demand, the recovery could end up be U/L-shaped, rather than V-shaped
  • Ultimately, we expect the COVID-19 crisis to cost each Indian between INR 8,000 to 16,000 in 2025 of missed economic growth compared to a benchmark scenario of no pandemic, depending on the shape of the recovery
  • In case of a U/L-shaped recovery, we also expect structural growth to decline from 5.7% to 5%, caused by lower investment and productivity growth. Lower productivity growth is the result of a possible rise in the share of zombie firms and de-globalization
  • The Modi government announced a 20 lakh crore stimulus package, including land, labor, law and liquidity reforms. If this package addresses India’s structural weakness and is properly executed, India’s economy could even emerge stronger from the COVID-19 crisis

Easing the lockdown

India is easing the restrictions of the COVID-19 lockdown that started on 24 March, although details on lockdown 4.0 are still unknown. As the Modi government apparently prepares to phase out the economic straitjacket in the upcoming period, the question is: will India’s economic recovery be V, U or even L-shaped? In this article, we describe two possible exit trajectories: a rapid recovery after a successful lockdown period, or structural economic damage during prolonged social distancing measures. We discuss the labor, capital and productivity mechanisms underlying these trajectories and estimate the economic costs for individual Indians in 2025.

Exit from an economic crisis – the stylized version

Figure 1: Stylized growth trajectory for Indian economy
Figure 1: Stylized growth trajectory for Indian economySource: RaboResearch

A severe economic crisis can affect a country’s growth trajectory in two ways (Figure 1). Firstly, the immediate bust causes a level shift in gross domestic product (GDP per capita), which is especially related to shocks on the labor market and to lower investment. Secondly, changes in the growth rate of the trajectory are related to damage to three factors: labor, capital and productivity, with the latter being the most important.

Two recovery scenarios: V versus U

We apply this framework to India’s economy in two scenarios. Our baseline scenario is a relatively strong recovery from the crisis in 2021, a so-called V-shaped recovery. This is based on the assumptions that the lockdowns are successful in containing and phasing out the virus, that there is no re-emergence of the virus requiring new lockdowns, and that the financial system and supply side of the economy survive the current crisis largely unscathed.

Our second scenario is that social distancing measures will be necessary beyond May. A recent study shows that even in the event of apparent elimination of COVID-19, social distancing measures could be necessary up to 2022 in order to prevent a re-emergence of the virus. In this social distancing scenario it would be sectors that find it hardest to adapt (like transportation and hospitality) that would suffer most. Taken with the possibility that – via knock-on effects – demand remains subdued in 2021, output might not rebound as sharply and the recovery could end up showing a U- or even L-shape. In this scenario, it is also more likely that the COVID-19 crisis will inflict structural damage to the economy.

Possible exit trajectories

Figure 2: The COVID-19 crisis could cost each Indian between INR 8,000 to 16,000 of missed wealth
Figure 2: The COVID-19 crisis could cost each Indian between INR 8,000 to 16,000 of missed wealthSource: RaboResearch, Ministry of Statistics & Programme Implementation (MoS&PI), Macrobond

Figure 2 shows the exit trajectories in the two scenarios discussed above plus a benchmark scenario showing the hypothetical trajectory without COVID-19 (green line). In the benchmark scenario we expect GDP per capita in 2025 to arrive at INR 143,000. In our baseline scenario with a clear V-shaped recovery (orange line), the economic losses in terms of missed economic growth compared to the benchmark would end up being approximately 11 lakh crore in 2025. This means that, on average in 2025, the COVID-19 crisis will cost each Indian INR 8,000 of missed wealth.

In the social distancing scenario with more of a U-shaped recovery (red line), economic losses pile up to more than 23 lakh crore, which means GDP per capita in 2025 ends up being INR 16,000 below the ‘no corona’ benchmark. In this scenario, the permanent damage to the economy is more substantial, as annual average structural growth between 2022-2030 also declines from 5.7% to 5%.

What mechanisms are behind these two crisis exit trajectories?

The COVID-19 crisis presents the Indian economy with a complex interaction between supply and demand shocks. Below we discuss the effects on the labor market, on the capital stock and on productivity.

Labor market

Figure 3: Unemployment is expected to exceed 30%
Figure 3: Unemployment is expected to exceed 30%Source: CMIE, Macrobond, RaboResearch

The size of the knock-on effects on demand, both in the short term and long term, partly depends on developments on the labor market. CMIE data shows that unemployment in India surged from 8.7% in March to 23.5% in April (Figure 3). We expect unemployment to peak at 31.5% in June, and slowly level off, depending on whether a social distancing economy (and the level of strictness) will be adopted after the hard lockdowns.

Employment usually does not pick up in tandem with production and part of the unemployed labor force will be unable to find a job immediately. Eventually, downward pressure on real wages will make sure that the labor market eventually clears, but in case of a rigid labor market like India’s, this will take quite some time and the risk of a ‘jobless recovery’ is substantial.

Figure 4: Participation levels have plunged from already low levels
Figure 4: Participation levels have plunged from already low levelsSource: CMIE, Macrobond, RaboResearch

In addition, CMIE data shows that participation rates plunged from 41.9% in March to 36.6% in April (Figure 4). This could indicate that people facing unemployment in the formal sector are resorting to work in the informal sector. If lower participation rates persist, this would clearly frustrate government attempts to formalize the economy and will weigh on tax revenues going forward.

Finally, young Indians especially might face what economists refer to as scarring effects, which can occur when people are forced to accept jobs below their skills level with a consequent rise in the share of people that become ‘trapped’ in lower-paid jobs. Some studies find that (early) unemployment spells result in a ‘wage penalty’ of 13% to 15%.


Figure 5: Growth of capital stock is hampered
Figure 5: Growth of capital stock is hamperedSource: RaboResearch, Macrobond, Penn World Tables

During an economic crisis, uncertainty and a higher risk premium lead to lower investment, and consequently lower capital accumulation. The lower level of the capital stock after the crisis also results in a downward shift in GDP (per capita) levels. Capital destruction can occur in case of an asset quality shock, for instance. This does not mean that capital goods are actually destroyed, rather that investments made prior to a crisis turn out to be worth much less than originally thought. The crisis then results in the contraction of some industries whose capital is not suited to changes in the economic environment. Shocks to capital and investment are amplified in case of a financial crisis. We currently do not expect India to face a financial crisis thanks to far-reaching interventions by the Reserve Bank of India (RBI), but we do foresee that the COVID-19 crisis will put a brake on growth of the capital stock (Figure 5).


Damage to productivity is the most important factor in relation to changes in the growth rate trajectory. Quite how the COVID-19 crisis will affect productivity in the long run is very uncertain. Geopolitical challenges and changes in business models may have both negative and positive effects on future productivity growth. Below we discuss three aspects which we believe might affect Indian productivity growth after the dust of the immediate bust has settled: a higher share of zombie firms, de-globalization and less investment in innovation.


The BIS has calculated that a 1% rise in the share of zombie firms (inefficient or unprofitable businesses) in a country reduces productivity growth by 0.3ppts. A weak banking system often results in a higher share of zombie firms, because weak banks facing stressed balance sheets have an incentive to rollover debt to zombie firms in order to prevent a write off of these loans. We expect non-performing loans at Indian banks to rise in the aftermath of the COVID-19 crisis, which also raises the risk that that more zombie firms will be able to continue their operations, if they survive the crisis.

Innovation and de-globalization

Figure 6: De-globalization will weigh on FDI in India
Figure 6: De-globalization will weigh on FDI in IndiaSource: UNCTAD, Macrobond, RaboResearch

What also might weigh on productivity going forward is a retraction of globalized dispersed value chains. As a result, economies are likely to become less open, with emerging markets benefiting less from international knowledge spillovers. Even before corona, we already expected that globalization would be put in reverse due to the US-China trade tensions and US attempts to undermine the World Trade Organization (WTO). The corona crisis, in our opinion, will speed up reshoring of activities that are currently performed overseas by multinationals as integrated supply chains unravel. And while India might perhaps benefit from firms exiting China or diversifying overseas manufacturing activities, we feel that the impact of globalized reshoring and a general lower foreign investment appetite will outweigh the potential benefits (Figure 6).

Finally, we expect lower productivity growth in the aftermath of COVID-19 as cash flow constraints and higher operating costs force firms to critically re-assess budgets for Research & Development (R&D) and innovation.

Strike while the iron is hot

Figure 7: Sweden is a successful crisis fighter
Figure 7: Sweden is a successful crisis fighterNote: g is the compound annual growth rate (CAGR) and is calculated for both trends
Source: RaboResearch, Macrobond, OECD, Statistics Sweden

Figure 2 shows a rather gloomy perspective for Indian economy in the years to come, but a more positive outcome is possible. On 12 May, Prime Minister Modi announced a substantial crisis package of 20 lakh crore (USD 270bn) including reforms of land, labor, liquidity and laws. Although it is too soon to assess the full economic ramifications of this package, the government is clearly using the current crisis as an opportunity to tackle India's structural weaknesses. If the crisis and reform package would be successful in addressing the rigid land and labor laws and ailing banking sector, we do not rule out that India’s economy could even emerge stronger from the COVID-19 crisis. The case of Sweden in the 1990s is exemplary how a policy and reform agenda focusing on strengthening the banking sector, fostering industry competitiveness and labor market modernization can really make a difference (Figure 7). Of course, the success of crisis policy depends on proper execution, so perhaps it would not be such a bad idea for Narendra Modi to give Stefan Löfven a call one of these days.

Hugo Erken
RaboResearch RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
+31 6 2223 1650

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