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Saturday, June 19, 2021

What India needs for economic recovery: policy support in general and fiscal support in particular

Dharmakirti Joshi writes: Without such support, recovery would be unbalanced, leaving a significant share of both companies and households in acute distress, even as overall GDP numbers show better growth.

Written by Dharmakirti Joshi |
Updated: June 2, 2021 8:07:36 am
A worker busy at a factory in the Wazirpur Industrial area as the unlocking process of COVID-19 lockdown begins, in New Delhi (PTI)

The latest provisional estimate of the Indian economy has, along expected lines, pegged the contraction in GDP at 7.3 per cent in 2020-2021. This provisional estimate essentially captures more updated information, particularly the fourth-quarter data, thereby leading to a closer approximation of growth compared to the second advance estimate released earlier.

The upward revision of the fourth-quarter estimates has trimmed the overall decline, but crucially, the impact of the pandemic on the informal sector has not been accounted for. That is likely to show up only in the “revised estimates” released in 2022, by which time attention would have shifted to the shape of recovery. This provisional estimate has a greater shelf life than the two advance estimates that preceded it, and thus provides a relatively stable base for analysts attempting to forecast the GDP trajectory in a highly uncertain environment.

The gap between GDP and GVA (gross value added) growth has been the widest since 2011-12 because of a sharp increase in subsidies, including arrears. That should, however, correct from the current year onwards.

The provisional estimate confirms that contact-based services — particularly tourism, hospitality, and airlines — were deeply scarred. These are a part of the “trade hotels, transport, etc” category which shrank in all quarters of the last fiscal year and posted the sharpest annual contraction of 18.2 per cent. Mining activity too was hit hard, but agriculture remained largely untouched by the pandemic and maintained its trend growth. This, despite being mildly impacted by adverse weather towards the fag-end of the monsoon season.

Manufacturing showed some resilience due to fewer restrictions and the ability to “live with the virus”, given it is less contact-intensive in nature. Construction, a highly labour-intensive sector, rebounded sharply in the second half primarily because of increased spending by the government on building highways and rural infrastructure.

But overall, the engines of demand — private consumption and investment — took a beating. Private consumption contracted by 9.1 per cent, and was only 3.1 per cent above the 2017-18 levels. The festive season and pent-up demand failed to offset the deep losses logged in the first and second quarters. Even policy support and the unwinding of household savings (RBI’s data shows they had plateaued at 8.1 per cent in the third quarter, down from a high of 21 per cent in the first), could not prop up consumption materially.

A similar story played out on the investment side, with gross fixed capital formation falling 10.2 per cent — a good 6.9 per cent below 2018-19 levels. Faced with the uncertainty, many private sector companies trimmed their investment plans. So much so that even the government’s push in the fourth quarter could not make good the gap for the full fiscal. Interestingly, net exports (exports minus imports), which typically contribute negatively to GDP, were less of a drag as import demand, driven by domestic economic activity, was much weaker than externally-driven export demand.

Now with the provisional estimates behind us, more uncertainty, downside risks and frequent changes to the economic outlook are in store. What’s worrying analysts, who are now gravitating towards a single-digit growth estimate for the current year, is the pace of the vaccination, especially because of the likelihood of a third wave. Another concern is the serious implication of rising economic inequality in the absence of strong fiscal support.

We have two downside scenarios to our GDP outlook of 11 per cent growth for 2021-22 — a moderate downside scenario with the economy growing at 9.8 per cent, and a severe downside scenario with growth clocking 8.2 per cent. Risks remain elevated on four fronts.

One, output and employment in contact-based services, battered by the second wave, remain vulnerable this year till vaccinations ensure community safety. But vaccinations will be ramped up significantly only after July or August.

Two, the rural economy may be less supportive this year than previously. The pandemic has penetrated far deeper into the hinterlands of Punjab, Maharashtra, Karnataka, Haryana, Rajasthan and Uttar Pradesh. This raises the risk of supply-chain disruptions for agricultural products. Growth in rural wages has also softened, and lack of enhanced fiscal support will keep rural consumption demand muted.

Three, while lockdowns and restrictions this time around have been less stringent, they are likely to be more prolonged. Till vaccinations reach a comfortable threshold, state governments will not rush to unlock economic activity, and will cross the river by feeling the stones. Demand for services will take time to return as fear among people after the second wave will not dissipate quickly.

Four, with private consumption remaining weak, private investments will take a backseat. Though large corporates have deleveraged and are in a position to invest, low capacity utilisation and uncertainty will discourage them from doing so.

Advanced economies (particularly the US and the UK) are recovering faster and growth is getting more broad-based to include services because of their success with vaccinations. They also suffered less last year due to generous fiscal and monetary support, which continues well into this calendar year.

India lags on both these counts. Till we have vaccinated a material level of the population, policy support in general, and fiscal support in particular, must serve as a bridge to recovery, especially for segments that have been hit hard in urban areas. To soften the blow to the rural economy, the government must priorities increasing the MGNREGA outlay and providing additional resources for ramping up health infrastructure.

The danger is that without such support, recovery would be unbalanced, leaving a significant share of both companies and households in acute distress, even as overall GDP numbers show better growth. The long-term consequences of that won’t be salutary.

This column first appeared in the print edition on June 2, 2021, under the title ‘Not a steady climb’. Joshi is chief economist CRISIL Ltd

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