A common thread that runs through the Economic Survey, the Union budget, and the RBI credit policy, one which is also held by India Inc., is that the economy is on the recovery path. This, in a way, is quite natural as the two quarters of negative growth in GDP were brought about by the closure of the economy, which was drastic in the first quarter and constrained in the second. However, post October, green shoots have been observed by policymakers, which combined with the strong policy support, justifies the feeling that the worst is behind us.
The third-quarter GDP numbers would be out by the end of this month and are expected to be marginally negative or even positive. The clinching factor here would be corporate profitability, which has been positive for the quarter. This is critical, as these numbers are used in the calculation of value-added, which is part of GDP estimation. Hence, a contraction in industrial production will not reflect in a contraction in manufacturing gross value added due to profits being positive. This is conceptual. The fourth quarter will register a positive growth rate, and as a consequence, the contraction for the full year will be between 7.5-8 per cent. From hereon, it will be only an upward movement. This is a reasonable assumption to make as most sectors have been witnessing closer to normal activity even in areas such as hotels, tourism, aviation, and media, which were probably more affected by the lockdown than manufacturing.
The contraction sets the pace for growth in 2021-22 which is now going to be critical as it is the foundation for the fructification of the budget revenue targets. It is believed that there will be double-digit growth in real GDP this year. This is being interpreted by analysts as being a V-shaped recovery and that happy days are back. True, statistically growth will be high and this will give the sense of a boom. This holds in all countries which have gone through a recession in 2020.
But consider this: GDP in 2019-20 was Rs 146 lakh crore, which has come down to Rs 134 lakh crore in 2020-21. Hence, a 10 per cent growth will take the Indian economy to Rs 147 lakh crore — when compared to Rs 145 lakh crore, this reflects modest growth. Therefore, expectations should be tempered when we talk of growth next year. Does this mean that it will be a mediocre performance? Probably not, as there will be a revival in economic activity on all ends which will probably bear fruit in 2022-23 — FY 2021-22 will be a year of consolidation.
Let us look at the policy architecture. The government has brought in a cogent policy framework right from the time of the Atmanirbhar announcements, culminating in the budget. There is a focus on infrastructure as well as providing incentives to investment through the Production Linked Incentive (PLI) scheme. Real estate, power and construction saw several policy reforms last year. There is a strong capex push by the government and the fact that the government is talking of a fiscal deficit ratio of 4.5 per cent by 2025-26 means that there will more action taken here.
The RBI has promised to continue accommodative policies, which sends a signal of managing liquidity notwithstanding the large borrowing programme of the government of Rs 12.8 lakh crore. We can expect more open market operations, and long-term repo operations during the year to ensure that interest rates remain stable. However, there will be concern around state government borrowings too, which will exert pressure on the availability of funds, considering that private sector demand has been lacklustre so far this year and will certainly pick up. Hence, there will be more central bank intervention in the market to ensure that funds are available.
Inflation is a concern as global commodity prices have already started going up and this has led to core inflation rising. In India, too, we have seen that the price of petrol and diesel is rising sharply. And with the government unwilling to relent on taxes, higher fuel inflation has the potential to upset inflation projections. Given that the monsoon has been good in the last four years, there is a possibility of an adverse season this time which can affect food prices. As such, it has been noticed that there are price shocks for vegetables, especially onions, every year, which have the potential to push up food inflation. Add to this rising manufactured goods inflation witnessed of late, and there is a possibility of inflation rising above the MPC’s tolerance levels. This will be something to watch out for.
What else will be crucial going ahead? Growth has to be driven by two engines — consumption and investment — this was our Achilles heel probably even before the pandemic set in. Consumption growth has been affected by the absence of commensurate job creation, which has come in the way of income growth. Good monsoons have normally been associated with high rural demand which feeds to the festival demand. This did not happen in 2018, 2019 and 2020. Hence, for growth to take place, consumption growth has to be real and rapid. This is unlikely too soon as consumption is dependent on job creation. Jobs get created when growth is high and hence there is circular reasoning here. Income has been affected in 2020 due to the pandemic which has led to job losses as well as salary cuts. This has affected the sustainability of the pent-up demand seen in October and November.
The second engine is investment which has lagged with gross fixed capital formation falling to a low of 24.2 per cent in 2019-20 from 34.3 per cent in 2011-12. This has to be reversed. This will be a challenge because post the non-performing loan problem, the demand for such projects has slowed down and banks have been wary of lending for infrastructure. There is also surplus capacity in industry with the capacity utilisation rate being 63.3 per cent in the second quarter of 2020-21. Therefore, private investment will rise only gradually and the onus is on governments to manage their targets: Both the Centre and states have to ensure that the wheels are moving. Private investment will follow, but at a slower pace and realistically speaking, will fire more in 2022-23 rather than 2021-22.
Therefore, the year 2021-22 will be one of cautious optimism. Growth will trend upwards, but it has to be interpreted with caution, keeping a check on the consumption meter, while pushing the investment pedal and keeping one foot firmly on the brake, or rather inflation.
The writer is chief economist, CARE Ratings and author of Hits & Misses: The Indian Banking Story (SAGE). Views are personal