Growth In Numbers: Some cheer amidst gloom.

Even after the GDP recovers to the pre-pandemic level, it is doubtful whether the Economy can resume being on a trajectory of 7%-plus growth.

In normal times, the contraction of the economy by 7.5% should have rung alarm bells. However, coming on the back of 23.9% contraction in Q1, the Q2 estimates show much faster rebound beating market forecasts—RBI’s monetary Policy Committee’s estimate (-9.8%) and the latest estimate of RBI (-8.6%). Even so, the contraction seen in the July-September quarter in India was the most severe among the major world economies with the exception of the UK, which showed a negative growth of 9.6%. The negative growth in two successive quarters has confirmed the setting of the recession in technical terms. Of course, better than expected performance brings in some cheer, it is too early to lift the gloom. Continued relaxation of the restrictions will help resume economic activities to reach the pre-Covid-19 level of output, probably in the last quarter of next year, but the growth trajectory is unlikely to return to the 7% plus we have witnessed for 20 years unless serious structural reforms are implemented.

In fact, several leading indicators did show that the economy was on the mend. The manufacturing PMI at 58.9 in October showed the fastest output increase in 13 years. The services PMI, after eight consecutive months of contraction, moved into a positive zone touching 54.1 in October as compared to 49.8 in the previous month. The core sector growth shrunk by just about -0.8% in September, though the October figures saw a contraction at 2.5%. There was also good news of passenger vehicle sales, which reflected a sharp increase in October with Maruti Suzuki recording 19% sales. The strong rebounding of exports in September created a current account surplus, though, in October, the exports declined by 5.4%.

As expected, the agricultural sector continued to maintain the growth momentum at 3.4%. The contraction in the industry at 2.1% was a surprise, as IIP after contracting by a steep 38% in the first quarter shrunk by just 6.7% during this quarter. Within the industry, manufacturing showed a remarkable recovery to register positive growth of 0.6% as compared to the contraction of 39.3% in the first quarter. The construction sector, which had seen the sharpest contraction at 50.3% in the first quarter, recovered to -8.6% in the second. The contraction in the mining sector continued at 9% as compared to 23% in the previous quarter. The only other services sector showing positive growth in the second quarter was electricity, gas and water supply (4.4%), which recovered from -7% in the first quarter.

The services sector was the most severely affected by the lockdown in the first quarter (-20.6%) due to social distancing restrictions, and it recovered barely to -11.4%. Trade, hotels, transport and communication sector continued to show double-digit contraction at 15.6%; although, this is a substantial recovery from 47% in the previous quarter. The recovery of this sector will continue to be staggered due to social distancing. The contraction in public administration and defence at 12.2% shows the impact of lower revenues on the spending by central and state governments. The revenue expenditure of the government, excluding subsidies, was compressed by 19.9% as compared to the sharp increase of 33% during the second quarter of FY20. A significant part of the compression must have come from the states due to the steep decline in revenues. This shows that there is hardly any direct support to revive consumption expenditures. This is also seen in the sharpest decline in government final consumption expenditure (22.2%). The private final consumption declined by 11.3%. The gross fixed capital formation continued to contract by 7.3% mainly due to the decline in government’s capital expenditures at both central, and even more, at state levels. The changes in stocks showed a growth of 6.2%, indicating the increase in inventory.

With the second-quarter growth better than expected, most forecasters will start revising their estimates for the remaining part of the year. There are questions on whether the recovery will continue at the same pace as seen in the second quarter. Agriculture will continue to be a star performer and with 13.9% increase in the acreage under cultivation in the kharif crops and high storage of water in reservoirs providing the comfort of a similar trend in rabi crop. However, the performance of eight core sector industries, after recovering to -0.1% in September has deteriorated to -5.4 in October. Although PMIs of both manufacturing and service sectors have shown good performance in October, it remains to be seen whether that will be sustained, particularly as in the northern part of India, Covid-19 cases are on the rise, and additional restrictions are being put in place. In any case, it is doubtful whether the FY20 levels of GDP can be reached any time before the fourth quarter of FY22. Besides progressive relaxation of restrictions, the most important stimulus the government can give is to clear all pending bills and tax refunds without delay. Furthermore, faster recovery requires government support in terms of increased revenue and capital expenditures, partly by increased borrowing and substantially by monetising the assets, including disinvesting.

Even after the level of GDP recovers to the pre-pandemic level, it is doubtful whether the growth trajectory of 7% plus growth witnessed in the last two decades can be resumed. It must be noted that the economy was already slowing from 8% in the first quarter of FY19 to 3.1% in the last quarter of FY20, and the investment levels during the same period had declined from 30% of GDP to just about 26%. With the balance sheet crisis affecting the corporates, banks as well as the government, there has been a sharp slowdown in investment activity. Thus, accelerating the growth trajectory requires addressing the structural problems. Almost two-thirds of the capital expenditures of the government, which supports long term growth, is at the state level and revenue constraints are likely to force them to compress this substantially. The government has taken some reform measures on land and labour markets and redefining MSMEs. This is the time to fast track reforms in banking and financial sector, provide stability and certainty in the policy regime including tax policy and administration, and provide the basic public good required to infuse confidence among the investors namely protection of property rights and enforcement of contracts.