Economic rebound could follow India’s steepest GDP fall

This is the worst performing year for India’s economy since India began publishing its gross domestic product (GDP) data. 1951-1952 was the fiscal year when India first began to publish its annual GDP data. This fiscal year, ending March 2021, the economy has entered a recessionary phase after seeing two successive quarters of sharp contraction. As per the recently released advance estimates on the Indian economy by the National Statistical Office (NSO), ahead of the Union Budget on February 1, the country's GDP will contract by 7.7% in the current financial year as against a growth of 4.2% in the previous fiscal. This will be as a result of a sharp contraction in the services, manufacturing, and mining sectors. This contraction, as estimated by NSO, would be the first ever witnessed in India in over four decades. The last time this occurred was in the fiscal year 1979-1980 when India's GDP contracted by 5.2%.

But the NSO's estimates aren't the only gloomy one out there. The latest estimates released by the World Bank paint an even bleaker picture. As per World Bank's Global Economic Prospects report, India's economy will contract by a whopping 9.6% in FY21, and is expected to recover upto 5.4% in 2022 as the rebound from a low base.

D.K. Srivastava, Chief Policy Advisor, EY India, speaking to Fortune India, argues that the NSO's estimate, which is lower by a margin of 1.9% points relative to the World Bank estimate, appears to be more realistic. “However, these estimates are contingent upon a significant turnaround in government expenditures supporting overall demand. This implies that in the last quarter of 2020-21, government spending, particularly by the centre, will have to be sharply uplifted. For this, it may be necessary to increase central government’s borrowing to 7.0% of GDP or above in 2020-21,” Srivastava says.

The advance estimates of GDP are calculated by evaluating indicators like the Index of Industrial Production (IIP) of the first seven months of the financial year, first advance estimates of crop production, cargo handled at major sea ports, commercial vehicles for the first eight months of the financial year, passenger and freight earnings of railways, passengers and cargo handled by civil aviation, financial performance of private listed companies till September, deposits, and credits and accounts of central and state governments.

“Similar to the previous years, the advance estimates (AE) for FY2021 have been based on the available data for six to eight months across various sectors. However, the modifications made in the extrapolation process seem to have captured the impending upturn expected in H2 FY2021, unlike earlier years, when the AE seemed to miss inflections that were underway in the second half, and ended up seeming to either over- or under-estimate the full year growth,” says Aditi Nayar, principal economist, ICRA, a Gurugram-based credit ratings agency.

Nayar points out that the performance of a majority of the available lead indicators, such as electricity demand, non-oil merchandise exports, rail freight, GST e-way bills, and vehicle registrations, has improved in Q3 FY2021 relative to Q2 FY2021, suggesting that the contraction in real GDP and GVA will narrow appreciably in Q3 FY2021 from 7.5% and 7.0%, respectively, in Q2 FY2021. “However, a portion of the improvement in profitability generated by the rising volumes, would be absorbed by rising raw material and employee costs in certain sectors,” she adds.

Based on an uptick in several indicators in past few months, some have upgraded their advance estimates. The Reserve Bank of India, for example, recently, in its monetary policy review said that the slide in growth is deeper than the 7.5% contraction as compared to its earlier estimate of a 9.5% drop. “While exports are on an uneven recovery, the prospects have brightened with the progress on the vaccines. Demand for contact-intensive services is likely to remain subdued for some time due to social distancing norms and risk aversion. Taking these factors into consideration, real GDP growth is projected at (-)7.5 per cent in 2020-21,” the RBI had noted. This roughly means a projected loss of ₹11.3 lakh crore of GDP in absolute terms from the last year. Economists argue that this is the first time India will witness a negative GDP growth rate after 1979-80, and the demand may struggle to go above pre-Covid-19 levels for the next few quarters.

Vivek Kumar, economist, QuantEco Research, however, is cautiously optimistic. He argues that it was the first quarter of the present fiscal which bore the maximum brunt of Covid-19's impact on the economy owing to the national lockdown, resulting in nearly 24% contraction. The second quarter, he feels, will be better. “As unlock progressed in a gradual manner, economic activity started to respond thereafter, with Q2 contraction in GDP tapering to 7.5% YoY. With further progress on unlock, revival in global activity, supportive policy environment, and pent-up demand, we expect economical revival to gain further ground with GDP growth turning positive in Q4 FY21,” he says.

Sector wise, as per NSO, agriculture (with an estimated growth rate of 3.4%) and electricity generation (with a growth rate pegged at 2.7%) are the only two that are projected to show positive growth. Trade, hotels, transport, broadcasting services, communication, etc. will see the steepest fall—and might show a contraction of 21%. “The maximum impact of Covid-19 has been seen in the contact intensive sector of trade, hotels, transport, communication and services related to broadcasting, which is estimated to contract by (-)21.4% in 2020-21. However, its rate of contraction is expected to come down to (-)12.0% in the second half of 2020-21 from (-)31.5% in first half of 2020-21. All other sectors excluding mining are expected to show a positive growth in the second half. Of these, the three prominent sectors namely (1) financial, real estate and professional services, (2) construction, and (3) public administration, defence and other services are expected to grow by 7.1%, 4.4% and 3.3% respectively in the second half of 2020-21,” EY India’s Srivastava says.

ICRA, similarly, estimates a weaker performance in FY2021 for sectors such as construction, financial, real estate and professional services (FRP), and public administration, defence, and other services , and a stronger performance for manufacturing, mining and quarrying, and trade, hotels, transport, communication and services related to broadcasting, compared to the advance estimates released by the NSO. “Improving economic fundamentals, resumption of remittances to the rural areas, healthy procurement, a bright outlook for the rabi season, and visibility of vaccine availability are expected to strengthen demand over the next quarter, resulting in an uptick in the pace of normalisation in volumes in many non-contact intensive sectors,” Nayar argues.

Exports, according to Nayar, may revive modestly in Q4 FY2021, as the vaccine roll-out gathers traction in the trading partners. “Moreover, improved tax revenue visibility is expected to boost the spending of the GoI in the rest of this fiscal. After a mild contraction in Q3 FY2021, we expect a tepid growth to emerge in Q4 FY2021, resulting in a full year contraction of 7.8% in Indian GDP in real terms, similar to the level of 7.7% projected by the NSO in the FY2021 AE,” she adds.

The World Bank in its report argues that the informal sector, which accounts for over four-fifths of India's employment, has been subject to severe income losses during the pandemic and recent high-frequency data indicate that the services and manufacturing recovery are gaining momentum. In a press briefing, the World Bank Group's president, David Malpass pointed out that it was India's poor who had to suffer the worst economic effects wrought by the pandemic.

“The inequality of the downturn and the likely recovery is dramatic. Those with the lowest incomes were worst hit by the downturn and would likely take the longest to regain jobs, healthcare, vaccines, and so forth in the post-Covid-19 economy. Those with job security, in contrast, and those at the top at the income scale were direct beneficiaries of substantial government and central bank support for their assets,“ Malpass was quoted as saying. “Key elements to the strength of the economic recovery would be investment that embraces the changed economic environment and an ability to reduce inequality,“ he had further added.

Budget hopes

Finance Minister Nirmala Sitharaman will present the Union Budget on February 1 for the upcoming financial year 2021-22 and experts believe that this year’s budget is crucial to decide the way forward from the current economic downturn. “The upcoming Union Budget for 2021-22 will lay the foundation for a post-Covid-19 recovery. It will support growth by uplifting the overall level of government expenditures to ensure a growth rate of 10% or above and a higher prioritisation of capital expenditure and health sector expenditure. This may involve keeping the fiscal deficit to GDP ratio in the range of 6-6.5% in 2021-22, while signalling a directional change towards restoring the path of fiscal consolidation although only in a limited way,” EY India’s Srivastava says..

He believes that as per the financing plan of National Infrastructure Pipeline (NIP), the private sector and the public sector will have to play a substantive role in this endeavour. “The central government will have to lead by example, and it may be required that both defence and non-defence infrastructure spending is uplifted, possibly at rates significantly higher than that for government revenue expenditure. The focus on health infrastructure would be both timely and would result in supporting construction sector activity which is associated with high output and employment multipliers,” he adds.

Economists also believe that sharp fiscal tightening should be avoided by both the Centre and the state governments, as it would temper the awaited economic recovery. “The budget should be focussing on the capital expenditure part because that has a significant blow in terms of investment appetite growth. A lot of support measures had been rolled out in the wake of the pandemic in the last 8-9 months. We would expect the government not to roll it back completely because that will have a negative repercussion. They should at least go for a partial rollback not complete rollback because the economy will still need that kind of consumption support,” says QuantEco’s Kumar.

He further argues that as compared to the global economy, India was an outlier in the April-June quarter in terms of taking the hit but that was mainly because of the severity of the lockdown. “That explains why there was a disproportionate amount of setback in terms of economic activity. But post that, we’re moving in tandem with most other countries. In FY22, we expect India to reach close to 11.5% GDP growth. That would be our first double digit GDP growth on an annual basis,” he says.

When it comes to South Asia as a whole, the World Bank’s report projects the region to grow by 3.3% in 2021. In Pakistan, growth is expected to be at 0.5% in FY21. In Bangladesh—which had been one of the fastest-growing emerging markets—growth is estimated to have decelerated to 2%. In the rest of South Asia, the economic impact of Covid-19 has been somewhat less severe but still significant. South Asian economies like Maldives, Nepal, and Sri Lanka that depend heavily on tourism and travel have been especially hard hit.

“Regional economic activity is estimated to have contracted by 6.7in 2020, led by a deep recession in India, where the economy was already weakened before the pandemic by stress in non-bank financial corporations,” the World Bank report read.

World Bank’s Malpass warns that without course correction investment could remain feeble for years to come. “To confront the adverse legacies of the pandemic, it will be critical to foster resilience by safeguarding health and education, prioritising investments in digital technologies and green infrastructure, improving governance, and enhancing debt transparency. Global cooperation will be key in addressing many of these challenges,” he had said.