Sometimes we miss the forest for the trees, and at other times the trees themselves become the story. That seems to be the case with India’s 3Q20 GDP print.
Some have exulted over headline growth printing a “better-than-expected” -7.5 per cent rate on a year-ago basis, while others, including the RBI, have lamented that this puts India in its first ever “technical recession”. But neither inference is meaningful. After clocking -24 per cent the previous quarter, printing a growth rate that is one percentage point higher than expected is nothing to write home about and, no, India is not in a technical recession.
The National Bureau of Economic Research (NBER) in the US defines a technical recession to be one where the growth rate is negative for two consecutive quarters. But the growth rate is measured on a quarter-over-quarter, not year-ago, basis. Almost all large economies, including China, publish official quarterly growth numbers. India’s CSO doesn’t. This leaves us to our own devices. JP Morgan’s estimates suggest that on a quarterly basis, India’s GDP plunged 25 per cent in 2Q20 and recovered by 21 per cent in 3Q20. India did not suffer two consecutive quarters of negative growth, and, therefore, it is not in a recession.
But the astonishing 21 per cent 3Q quarterly growth is also not something one should take much comfort in. If the level of GDP was 100 in 1Q, then it fell to 75 in 2Q and recovered to about 92 last quarter, it is still about 8 per cent lower than the level in 1Q20. In fact, we expect GDP growth in FY22 to recover to 12 per cent from -9 per cent in FY21, which implies that six quarters from now it will still be about 7 per cent below the pre-pandemic path, or roughly $300-billion-a-year of income losses across two years, compared to the pre-pandemic path. Imagine the havoc this can wreak to household and SME balance sheets, to income inequality, to poverty, and to women’s employment, since much of the economic shock has been borne by services, where female employment is much higher than in manufacturing.
While not avoidable, much of the income loss could have been mitigated by budgetary income support. But the government chose not to provide this. And this shows up clearly in the 3Q GDP numbers. Government consumption declined 22 per cent on a quarterly basis in 3Q. The government’s unusual reluctance in providing adequate support to the economy has purportedly been because of the lack of fiscal space. This seems quite odd. The private sector’s excess savings (savings less investment) is so large that instead of borrowing from abroad (running current account deficits) as it usually does, India has been investing abroad, that is, running current account surpluses.
Over the last five years, India’s current account deficit averaged 1.6 per cent of GDP annually. This turned into a surplus of 4 per cent of GDP in 2Q20 and JP Morgan projects it to average 1.6 per cent of GDP this fiscal year. Consequently, despite the apparent lack of fiscal space at home, the RBI has been funding other countries’ fiscal deficits. Since April this year, the RBI has bought $70 billion of foreign assets, presumably mostly US government bonds. That’s roughly 2.7 per cent of GDP. Put differently, while the government has limited its support to the domestic economy, it has, via the RBI, invested almost 3 per cent of GDP in foreign assets just in the first half of this fiscal year!
Separately, the RBI reported last month that profits of non-financial listed firms surged (35 per cent in nominal and about 30 per cent in real terms) in 3Q20. We know that wages and profits make up the bulk of GDP. So if GDP fell by 7.5 per cent and profits of listed companies increased by 30 per cent, it stands to reason that wages, employment, and earnings of SMEs plummeted. The Centre for Monitoring the Indian Economy’s surveys suggest the employment rate is still more than two percentage points below its pre-pandemic level, translating into more than 10 million fewer jobs today. After improving after the lockdown, the employment rate has plateaued since July, consistent with almost 10 million more rural households seeking MGNREGA employment per month since August compared to a year ago. And herein lies the “fallacy of composition” or the “tragedy of commons” problem. It may be rational for each firm to cut back employment or wages, but if all firms do the same, they are simply hurting future consumption and, thus, their own future demand and profits.
There is an obvious solution to the problem, but it is not spending on infrastructure projects or reforms as is widely believed. As long as the pandemic persists, mobility will remain limited. So while infrastructure spending and reforms are critical to sustain medium-term growth, neither can boost near-term demand. The pandemic is still not behind us and for now India will need to hunker down as long as it takes for the vaccines to create herd immunity. Once immunity has been achieved, mobility will normalise and the recovery can begin in earnest. What needs to be ensured is that the recovery is not hamstrung by damaged household and SME balance sheets because of the extended loss of wages and incomes. This requires extensive income support now. It is not so much that it will help support demand this year, but that it will protect balance sheets from the extensive damage the pandemic has already signalled it will likely leave in its wake.
Unlike typical EM crises, the pandemic is not an instance of a financial crisis turning into an economic shock. Instead, it is an economic shock brought on by a weak public health system that can turn into a financial crisis if the damage to balance sheets is not limited by policy. The government, however, has eschewed going down this path. And it must have good reasons for doing so. But, as discussed earlier, the lack of fiscal space isn’t one of them.
This article first appeared in the print edition on December 15, 2020 under the title ‘The prospects for recovery’. The writer is Chief Emerging Markets Economist, JP Morgan. Views are personal.
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