Updated: September 14, 2021 2:23:51 pm
Last week, the Ministry of Statistics and Programme Implementation released the GDP (gross domestic product) and GVA (gross value added) data for the first quarter of the current financial year. The government used the Year-on-Year (Y-o-Y) comparison method — which showed that the GDP grew by 20% in Q1 this year as against the Q1 last year — to claim that India was witnessing a V-shaped recovery. Critics of the government chose to look at the Quarter-on-Quarter (Q-o-Q) method — which showed the economy contracted by 17% in Q1 this year as against Q4 (January, February and March) of the last financial year — to claim that the economy was fast losing momentum.
So, which is telling the truth? What is the truth about the current state of the Indian economy?
The short answer: Both — the government claims of a V-shaped recovery and the critics’ claim of a sharply contracting economy — are misleading.
What’s more, either of the claims would lead to faulty policy choices which, in turn, will hurt India’s future growth.
To understand why and how this is the case, let’s take a detour.
One of the most fundamental mistakes by Indian policymakers in the pre-Covid era was the incorrect diagnosis of India’s economic growth momentum. For the longest time, the Indian government refused to accept that the economy was decelerating sharply. Many of you would recall that India’s annual growth fell sharply from over 8% in 2016-17 to just about 4% in 2019-20. But for most of this intervening period, India’s finance minister refused to accept that there was a steady and indeed sharp slowdown underway.
Apart from the refusal to accept the slowdown, the government had also made matters tough for itself by advancing the traditional date of presenting the Union Budget by a whole month. While this may sound like an innocuous change on the surface, in reality, it hamstrung the government from correctly assessing the state of the economy while undermining the credibility of its Budget numbers. Read this explainer to know how.
The combined effect of inadequate data and a refusal to accept the rapidly worsening state of the economy resulted in flawed policy choices. The most important one being the cut in corporate tax rates. To be sure, lower corporate tax rates can be listed as a bonafide reform and it should help India’s industry in the long-term, but its timing left a lot to be desired. Read this explainer to understand why.
The central problem was that it was announced at a time when India was facing a rapidly worsening demand problem. In other words, people’s incomes were either growing at a slowing rate or actually contracting. Add to that the high unemployment levels which had become endemic.
Altogether, what ailed with the Indian economy was inadequate demand. But what the corporate tax cut attempted to do was to boost supply — the exact opposite of what was required.
The results were hardly surprising. Even before the Covid pandemic, corporations simply pocketed the tax relief — estimated to be anywhere between Rs 1.5 lakh crore to Rs 2 lakh crore — and used it to either pay off their debts or boost their profits, without even a single penny rise in net investment.
It can be argued that a better alternative would have been to provide a monetary boost of the same amount to consumers instead of the producers. This could have been done either in the form of increased direct spending from the government or in the form of tax relief (say a reduction in GST rates or income tax rates).
You may well say: This was all before Covid; so why bring this up now?
That’s because we may be repeating the same mistake — thanks to the government’s ambitious claims that India has registered a “V-shaped” recovery.
Since early last year, when the Covid pandemic hit the Indian economy, ExplainSpeaking has repeatedly underscored the need to look beyond percentage change, and instead focus on absolute numbers. In large part this has to do with the fact that in times of massive upheavals, percentage change can be quite misleading. Why? Because a 25% reduction of Rs 100 — equal to Rs 25 — is more than a 25% increase in Rs 75 — equal to Rs 18.75. While both the fall and rise percentages are the same, the impact in absolute values is quite different; the final value is almost Rs 7 short of the original.
Let’s first look at the government claim.
As a detailed analysis of both the GDP and GVA data in The Indian Express (https://indianexpress.com/article/explained/india-q1-gdp-data-economy-covid-impact-modi-govt-7481191/) showed, when one looks at absolute numbers, the picture is far from rosy. I have reproduced the Tables for GDP and GVA below and they show that both GDP and GVA — the two ways in which national income is estimated — are back to levels last seen in 2018.
Look at the GDP data table first.
CHART 1: GDP (at 2011-12 Prices) in Q1 (April-June) of 2021-22 falls back to levels last seen in 2018 (In Rs Crore)
|Engines of Demand||2017-18||2018-19||2019-20||2020-21||2021-22|
|Private Final Consumption Expenditure (PFCE)||17,83,905||18,89,008||20,24,421||14,94,524||17,83,611|
|Government Final Consumption Expenditure (GFCE)||3,63,763||3,93,709||3,92,585||4,42,618||4,21,471|
|Gross Fixed Capital Formation (GFCF)||9,89,620||10,82,670||12,33,178||6,58,465||10,22,335|
|Net Exports||—1,44,175||— 1,22,238||— 1,70,515||34,071||— 62084
|Total GDP* (an L-shaped recovery)||31,62,537||33,59,162||35,66,708||26,95,421||32,38,020|
|GDP for a V-shaped recovery||31,62,537||33,59,162||35,66,708||26,95,421||40,07,553|
(Source: MoSPI) The total figure includes three other components namely “Change in Stocks”, “Valuables” and “Discrepancies”.
It shows that private consumption demand — the biggest driver of India’s GDP (accounting for more than 55% of all GDP) — is almost exactly back to where it was in 2017-18.
So, if India’s consumer demand is back to the 2017-18 level, what should the government do? Raise its spending so as to boost aggregate demand.
But now look at what has happened to government spending (GFCE in the GDP table): It has fallen from the levels where it was last year. In other words, the reduction in government spending pulled down the overall economic growth rate in Q1.
What’s worse, if the government continues to believe that India has already staged a V-shaped recovery, it may not find any reasons to spend more, thus creating a similar drag on future growth.
That is why it is important to understand why the government is wrong in its claim that India has staged a V-shaped recovery and why it needs to boost its spending if it wants to secure future growth momentum.
For those who do not understand what different shapes of recoveries mean, here is an explainer.
Essentially, a V-shaped recovery means the economy quickly reverts to the trend of absolute GDP.
So if India’s GDP was growing at 6% before the pandemic and we assume that it would have grown at 6% in 2020-21 and 2021-22 without the Covid disruption, then the Q1 GDP should have been Rs 40,07,553.
In reality, it is only Rs 32,38,020. In other words, the trend level of GDP is 24% more than what the actual GDP was in Q1.
To further understand how far away India is from a genuine V-shape recovery, let’s calculate the number of years it would take for India to post a Q1 GDP of Rs 40,07,553. Let’s suppose India grows at 7% (Year-on-Year) in the first quarters of 2022-23, 2023-24 and 2024-25. If that happens, which is a slightly optimistic assumption, then at the end of June in 2024-25, India’s Q1 GDP would be Rs 39,66,714 — still short of the level that constitutes a V-shaped recovery in 2021-22.
The reality — a Q1 GDP of Rs 32,38,020 — points more towards an “L-shaped” recovery instead of a “V-shaped” one.
The story is equally worrisome when one looks at the GVA data. In fact, for some sectors that create the most jobs in India — such as Construction and Trade, Hotels, Transport, Communication & Services etc. — the picture is much bleaker as the GVA levels have fallen back to 2017-18.
CHART 2: GVA (at 2011-12 Prices) in Q1 of 2021-22 (in Rs Crore)
|Agriculture, Forestry & Fishing||4,04,433||4,27,177||4,49,390||4,65,280||4,86,292|
|Mining & Quarrying||95,928||88,634||82,914||68,680||81,444|
|Electricity, Gas, Water Supply & Other Utility Services||67,876||74,998||79,654||71,800||82,042|
|Trade, Hotels, Transport, Communication & Services related to Broadcasting||5,63,038||6,09,330||6,64,311||3,45,099||4,63,525|
|Financial, Real Estate & Professional Services||7,28,068||7,57,850||8,02,241||7,61,791||7,89,929|
|Public Administration, Defence & Other Services*||3,57,203||3,87,589||3,99,148||3,58,373||3,79,205|
|GVA for a V-shaped recovery||29,62,815||31,57,366||33,05,273||25,65,909||36,44,063|
Public Administration, Defence & Other Services category includes the Other Services sector i.e. Education, Health, Recreation, and other personal services (Source: MoSPI)
If one calculates the GVA level that a V-shaped recovery would require, one finds that it is 20% more than what the actual Q1 GVA is. Again, even if GVA grows by 7% (Y-o-Y) from here on, it will take another three years just to cross the level that marks a V-shape recovery this year.
Of course, in three years time, both GVA and GDP would have grown much higher according to the original trend line and that is why the reality may be closer to an L-shaped recovery, which points to a permanent loss of GDP and GVA.
Of course, Covid is a global pandemic and it has left no economy unscathed. But the point of this analysis is to correct the misconception about the shape and form of the economic recovery so that the government can make smarter policy choices this time around.
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For instance, if there is a consensus that India suffers from weak consumer demand (as shown by the Private Final Consumption Expenditure (or PFCE) component in the GDP data table) and that Indians across several sectors of the economy are earning much less than what they were doing in the past (as shown by the GVA data table) then the government can think in terms of either boosting its spending in such a manner that beefs up the incomes of the worst-hit or provides a tax relief — say a cut in GST rates or taxes on petroleum products — to improve the purchasing capacity of the consumers.
Lastly, what about the critics of the government who claim that Q-o-Q, the GDP has contracted by 17%?
Well, for one, if one looks at the Q-o-Q method then India’s GDP rebounded quite fast in the Q2 (July, August, September) of the last financial year itself! What makes this even more bizarre is the fact that by the Y-on-Y method, India went into a technical recession in Q2 of the last financial year.
Moreover, in India, often enough, the quarterly GDP levels tend to go up with each passing quarter in a financial year, and such a contraction may be visible even during normal times — that is if one compares Q1 of any financial year with the preceding Q4.
But perhaps most importantly, as this piece explained, there is a distinct seasonality to India’s annual growth and a Q-on-Q approach, while being a globally accepted norm, is sub-optimal for assessing its growth momentum.
Again, believing that the economy contracted by a whopping 17% in Q1 — when it may be recovering, albeit far more feebly than what the government claims — could again lead to flawed policy choices.
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