Economy is doing better in year’s second half. Pandemic scars won’t be erased merely by growth

Between January and May each year, India gets to see two “advance” estimates and one “provisional” estimate of GDP growth, as more data becomes available. The revision to the current fiscal year’s contraction from the 7.7 per cent forecast in January to 8 per cent now in the second advance estimate is not surprising.

But the crucial number will be in the May “provisional estimate”, considered more reliable and with a longer shelf life as the next revision (called the first revised estimates) will be available only in calendar year 2022.

Particularly for India, even those figures could change in the final estimates as economic activity in the vast informal sector is hard to assess and does not get reflected in the advance and provisional estimates. What happens there is confirmed more than a year later when the economy has moved on.

That said, this fiscal year’s additional complication is the pandemic. Data availability and forecasting in a fast-evolving scenario becomes difficult and comes full of surprises. In the first quarter, the surprise was on the downside, with GDP contracting at 23.9 per cent (now estimated at 24.4 per cent). From the second quarter, it has been on the upside, with third-quarter GDP growth estimated to have moved into the mild positive territory (0.4 per cent).

But all this does not change the emerging story of 2020-2021, which is essentially a year of two distinct halves. The economy has moved up from a steep of 15.9 per cent contraction in the first half to flattish growth in the second half as per second advanced estimates. It’s important to understand why that happened to know what needs to be done.
First, is the fortuitous combination of people learning to live with the virus along with the flattening of the COVID-19 curve in the second half. The first wave of afflictions peaked in September, with the active case count per million dropping to 113 in February from 701 in September. This led to a gradual lifting of restrictions, improving mobility and economic activity across-the-board, except in services.

Within services, the contact-based ones such as trade, hotels, transport and communication have continued to contract in the second half, albeit at a slower pace. These segments will remain weak till the time herd immunity/vaccination drive reaches a critical mass, infusing widespread confidence in their consumption. This also means that the urban economy, which accounts for over two-thirds of these services, is still ailing.

Two, overall, government consumption expenditure has risen, though only by around 2 per cent on-year. As central government spending has been strong, the drag is likely from the states. The budget data also shows a notable lift in investments by the Centre in the second half.

The nature of government spending — on roads, highways and metros — has benefited the labour-intensive construction segment. Real estate construction has also picked up in select regions, with lower housing loan rates, developer discounts and reduced stamp duty rates spurring buyers. Consequently, construction GDP growth is projected to rebound sharply from a contraction of 29.1 per cent to a growth of 7.4 per cent between the two halves.

Three, manufacturing activity rebounded quickly once supply restrictions were lifted, logging 1.6 per cent on-year growth in the third quarter, with the momentum continuing into the fourth. A shift in spending away from services (such as money saved on holidays) to purchase of items also seems to have contributed — the government’s leave travel concession cash voucher scheme also facilitated this transition. Additionally, the wealth effect from soaring stock markets has raised the spending ability of households with exposure to them.

However, some of these drivers may not play out in fiscal 2022.

Though interest rates are likely to remain supportive, there is an upward price pressure on durable goods due to a rise in input costs and commodity prices. Weakness in contact-based services will restrict demand for products from this segment. Steady growth will need a sustained lift in household incomes.

Agriculture GDP growth of around 3 per cent this fiscal (holding steady in both halves) confirms the resilience of the farm economy to the pandemic. A normal monsoon, a bumper crop and high food inflation in wholesale markets has contributed to rural incomes. Government support in the form of MGNREGA and PM-Kisan allocations, along with record procurement in 2020, have also helped.

In the next fiscal, we expect GDP to grow at 11 per cent. Yet, the pace will return to the pre-pandemic level only by the second quarter, and the full-fiscal real GDP will be barely 2 per cent higher than 2019-20, underscoring a permanent GDP loss of around 11 per cent.

The pandemic will also leave a lot of scars that may not be erased merely by higher growth. While growth is important, so is policy intervention to address the distributional ill-effects of the pandemic, particularly for small business units and the urban poor. In short, this is not an easy recovery.

An effective combination of vaccination and herd immunity will take time to materialise and till that happens, the risk of a second wave looms. Rising cases in Maharashtra and Kerala are a grim reminder of that. A firm control over the pandemic is a pre-condition for a broad-based recovery that includes contact-based services.

But, even as fiscal policy remains supportive of growth, monetary policy has limited ability to juice up the economy.

The premature withdrawal of policy support in advanced countries could also threaten their growth prospects, and in turn, that of emerging markets as well.

Looking beyond a near-term recovery, it’s also important to ask: Will India build back better and revert to its pre-pandemic decadal growth trajectory of 6.5-7 per cent annually over the medium run, given fiscal and monetary policy normalisation? For that, the revival of the investment cycle is critical.

Some parts of the private sector, which have de-leveraged and have cash balances, are primed-up for undertaking investments, with the production linked incentive scheme giving them a leg up.

But for a broader and more sustainable revival, the trigger will still need to come from government investment spending (both Centre and states) with higher multipliers, crowding in private investments. The lift in the investment growth to 2.6 per cent in the third quarter provides some hope.

Joshi is Chief Economist, CRISIL Ltd

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