1. Nagaraj DECEMBER 03, 2020

Using the latest quarterly estimates to point to an economic rebound seems flawed; recovery is likely to remain modest

The decline in the quarterly GDP growth rate, by 7.5% during July-September 2020 (FY 2020-21: Q2), compared to a 24% decline in the first quarter has raised expectations of a sharp economic recovery after the novel coronavirus pandemic and the national lockdown. But is such optimism justified?

A tracker

India’s GDP at current prices in 2019-20 was ₹204-lakh crore, or $2.8 billion at an exchange rate of ₹73 to a dollar). Its growth rate over the previous year (2018-19) was 5% in real terms, that is net of inflation. The economy, expectedly, slumped after the pandemic and the economic lockdown in March this year. Output contracted by as much as 24% during April-June 2020 (FY 2021: Q1) compared to the same period last year. In June, economic activity resumed as the lockdown began to be gradually lifted. Expectedly, output recovered sharply, reducing the extent of contraction. During the July-September quarter (FY2021: Q2), output growth contracted by 7.5%, compared to the same period in the previous year, an official press released last Friday showed.

The economic rebound is being hailed as a vindication of the government’s decision (though harsh) to impose the national lockdown at four hours’ notice as well as the success of the relief and revival packages that were announced by the Centre later. By extrapolating from the latest quarterly estimates, many believe that the adverse effects of the lockdown would be behind us by the end of the current financial year in March 2021.

But such optimism is in contrast to widespread academic and informed opinion that is of the view that India had introduced one of the strictest lockdowns in the world which has resulted in the sharpest output contractions and massive losses in terms of jobs and livelihoods. So how credible is the popular optimism?

On expected lines

To begin with, not much should be read into the quarterly national income estimates as they are mostly extrapolations or projections of the annual estimates, using rates and ratios. Very little up-to-date primary information from farms, factories and offices is available for the estimation. However, the quarterly figures do indicate the broad direction of change. In this case the change is on the expected lines.

That said, some estimates seem anomalous. Manufacturing sector output growth witnessed the sharpest rebound: from a negative 39% in the first quarter to positive 0.6% growth in the second quarter looks too good to be true. Corresponding figures for the Index of Industrial Production (IIP), based on physical output indicators, are minus 40.7% and minus 6.8% respectively. The groundswell for the suspicions are prima facie valid given the long-standing dispute over the estimation of manufacturing sector GDP on account of questionable corporate sector quarterly financial returns. Nevertheless, one should cautiously analyse the quarterly variations between GDP and IIP numbers as there are too many factors that could account for the observed discrepancies.

There are, however, more serious and substantive issues to grapple with, considering the opportunistic biases that dominate the public discourse. The lockdown shaved off nearly one-fourth of the yearly output in the first quarter. The output during the first half of the year (April-September 2020) (FY2011: H1) is just about 40% of the GDP in 2019-20 at constant prices. The economy has to grow at an unprecedented rate in the remaining two quarters to climb back to the output level of 2019-20.

Do prospects look bright for such growth rates? The answer is doubtful for the following reasons.

Demand is still weak

The healthy recovery in the second quarter met the pent-up demand for industrial goods and to re-build inventories. Aggregate demand is still very weak. Despite much vocal support, the government’s current and capital expenditures have hardly moved up in the first half of the year when compared to the previous year.

The government’s debt-GDP ratio has gone up though, mainly to make up for revenue shortfalls. Bank credit growth in the economy continues to decelerate — 5.1 % in Q2, when compared to 8.8% in the same quarter last year.

After the sharp recovery of output in the second quarter, many high frequency output indicators — that is, those economic variables for which up-to-date information is available at shorter time intervals — suggest the momentum of recovery to be tapering off. For example, the official infrastructure index of eight core sector industries (namely, coal, natural gas, crude oil, refinery products such as petrol and diesel, fertilizers, steel, cement and electricity) declined by 2.5% in October over the same period last year. The cumulative growth of the index from April to October this year stood at negative 13% when compared to the same period last year.

Balance of payment surplus

The opportunist bias in public perception is also based on related aggregate economic indicators beyond production trends. The Chief Economic Adviser has exuded confidence that the financial year is likely to end with a balance of payment surplus, as a badge of good economic management. This is surprising since elementary economics would make it clear that balance of payment surplus for a developing country means that it is importing less than the warranted rate of import growth for maintaining sustainable output expansion. Most of the shortfall is on account of a sharp decline in investment demand, denting potential output.

Similarly, populist optimism is based on rising foreign exchange reserves and a booming stock market. They are taken as evidence of global confidence in Indian economic policy. These are fallacious measures. India’s burgeoning foreign exchange reserves are made up of short-term debt flows; they are not our net export earnings (unlike China’s).

Similarly, the booming stock market is almost entirely driven by short-term foreign capital inflows, propping up the balance of payment. They are a sign of the economy’s weakness — not strength — as such inflows are highly fickle, representing hot money, which can quit the financial markets in a jiffy if perceptions change for any exogenous reason.

The prognosis

In conclusion, a sharp recovery in the second quarter GDP — thus reducing the decline in the quarterly growth rate — represents meeting the pent-up demand after the ‘Unlock’ phase started in June. One should not attach too much value to the precise number of quarterly growth rates as the underlying estimation methods and the data used are weak and questionable. Whether the tempo of recovery will be maintained and whether India will wipe out the negative growth for the current year are open to doubt. Many high frequency data series suggest moderation of the recovery after the initial bounce from the ‘Unlock’ phase. Since additional expenditure on government consumption or investment or credit growth remain muted, the recovery is likely to remain modest for the year as a whole. There is little room for exuberance given the limited boost to aggregate demand to sustain the recovery momentum.

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