September 7, 2020 2:30:31 am

The income split shows growth in agriculture compared to the first quarter of last year. There have been minor declines in financial services and utilities, and major declines in retail, transportation and manufacturing. (Photo: Jasbir Malhi/Express Archive)

By Neelkanth Mishra

How should one read the first-quarter GDP data and the contraction by 23.9%? What signal does it offer for the future? And does it give any idea of the sectors that the government must prioritise?

Compared to the first quarter of last year, the income split showed growth in agriculture, minor declines in financial services, utilities (like electricity and water) and public administration, and major declines in retail, transportation, manufacturing, hotels, and construction.

The expenditure split showed growth in government spending, private consumption was down by a quarter, and investments nearly halved. On both fronts there was little surprise in the GDP release.

The quantum of decline seems to have surprised many, but it should not have.

The first lockdown curtailed nearly two-thirds of GDP, and while this proportion came down in subsequent phases, till the end of May activities adding up to nearly a fifth of GDP were still restricted. Even in August, we estimate, up to 9 per cent of GDP was restricted either by regulation or fear.

While the economic trajectory going forward would be affected by the wealth and income losses seen in the past five months, the decline in the June quarter was almost entirely due to activity restrictions. Now that there is an official measure, however inaccurate, of the scale of losses, the first priority should be to remove as many of these restrictions as possible.

While the Union government caught on to this by May, state and local governments are still using unproven administrative measures like lockdowns on weekends or on random days, or quarantines for travellers. Further, seroprevalence studies in several cities are now showing fatality rates of one or less per thousand infections; more such studies are needed to reduce fear among the people.

This release should also allow the government to calibrate its fiscal response. With a steady recovery in growth rates till the end of the year, the full year decline would be around 10 per cent, or a loss of about Rs 20 lakh crore.

We estimate that about half of this would be felt by the government in the form of lost taxes and some extra expenditure, such as free grains. About a fourth would be borne by wage earners. Given that consumption was also affected by restrictions, the lasting impact would be smaller. The worst affected would be informal firms and low-income households, which would exit the pandemic with fewer assets or higher debt. This could impair their economic potency for a long time, unless the government intervenes fiscally, spreading the losses over current and future citizens through a rise in sovereign debt to GDP: as close to “water under the bridge” as one can get.

How should we read suggestions that the scale of contraction may not be correct since the damage to the informal economy is not being captured in the GDP data?

More than 40 per cent of our GDP is informal, meaning there is no data even on an annual basis. GDP data in India, therefore, are prone to large revisions — it is a calculation more of an estimate than a measurement until at least the second revised estimate that is published two years later.

Quarterly GDP calculations must rely on even less hard data than available annually, projecting formal economy growth rates on to the informal economy for several activities. It is possible that the growth rates may have been overstated, as anecdotal evidence suggests that in many sectors, formal firms gained share. However, it is hard to quantify this.

GDP projections for the July-September quarter also point towards a contraction, but shallower than the one seen in April-June. Does this imply that GDP growth has bottomed out? How are readings of other high frequency data points and other numbers beyond the first quarter?

The year-on-year growth momentum going forward should be better than in the first quarter, as activity restrictions are progressively relaxed, and people’s fear of the virus reduces. All activity indicators we track show a much better reading now than they did between April and June.

However, the pace of the rebound has slowed since July. This has two drivers.

One, there still exist restrictions on several economic activities – for example, just transport to and from schools/colleges is a Rs-1,20,000 crore business. Similarly, demand for ethnic premium apparel, used for festivals and family events is subdued. Nearly a fifth of milk is consumed out-of-home. Activities at large construction companies are still not back to pre-crisis levels.

Two, the effects of the weak economy in the last five months will now start showing up. Some businesses have shuttered, and the sharp increase in economic uncertainty that we saw since March would have changed savings and investment behaviour for many others.

The economy is, therefore, far from normal, and may stay that way for a while.

CPI-WPI inflation rates have been displaying divergent trends, with WPI staying in the negative territory, reflecting weak pricing power, while CPI has been rising, staying above the RBI’s comfort level. Is the country headed towards a long phase of stagflation and recession?

One should try not to read too much into inflation data currently for three reasons.

First, the consumption basket is currently very different from what CPI is based on.

For example, the weight of market-priced rice in CPI is nearly 10 times the weight of PDS rice (i.e., subsidised rice) in CPI. However, today a large part of the population is getting free rice; if this showed up in CPI, inflation could be 200 basis points lower. There are numerous such examples.

Second, as local lockdowns impede normalisation of supply chains and markets, shortages are appearing. So much so that firms now say that market share gains will be supply driven (that is, who gets hold of the supply) rather than demand driven. This is also showing up in lower discounts.

Lastly, uncertainty is impeding supply resumption even in basic categories like vegetables, where farmers are unwilling to plant certain crops because they are afraid of not being able to sell the harvest. This is where the stagflation risks can emerge – if the amount of chicken consumed is down by a third but prices are up 5 per cent, the focus should be on reviving supply rather than raising rates. The challenge, thus, is to reduce economic uncertainty so that more businesses do not shut down, as reviving supply is far more difficult than reviving demand.

So far the government has mostly relied on the RBI to support the economy; is it time now for a big bang fiscal push to generate growth and employment? And given that the government does not have the fiscal space for such a push, how can this space be created?

There is a need to socialise at least some of the losses for the smaller and informal firms and low-income households. Given weak financial penetration in India, monetary steps are likely to have limited impact on these entities.

The challenge appears to be less a lack of fiscal space and more the central government’s worry that undirected large schemes create economic distortions and corruption. Many of the areas that require investment are state subjects, and there appears to be a lack of trust between the Centre and the states on leakages, should a large unconditional allocation be made to states.

This is resolvable – we have already had successful schemes where the Centre provided funds and also executed works in areas that are state subjects, such as rural roads, rural housing and sanitation, and now even drinking water provision. New schemes focusing on areas that trigger widespread demand — say, the creation of a hospital in every block — may be necessary.

What can the states themselves do to push growth?

State governments have fiscal stress, but they also have more administrative control. They should look to permit as many activities as possible. For example, there is no need for quarantines for travellers now when most districts in India have a thousand or more infections already. Each state also has its own niche sectors that may not be as important nationally — like tourism in Goa, Kerala and Rajasthan, or dairy in UP — that it can devise policies for.

There is a clamour for a fiscal push — increased spending by the Centre. But what could be the means to raise such resources?

The current excess of incoming dollars is likely to last. Instead of the RBI letting the rupee appreciate, it may choose to allow excess funds in the domestic economy to rise, which can help the government raise funds cheaply. Further, with interest rates globally likely to be low for quite some time, and capital markets on a tear (issuance of debt and equity is already at a record high), the government can divest assets in real estate, steel, copper, iron ore, oil marketing, banking and insurance, to create new assets in healthcare, education, and social safety.

The expert

Neelkanth Mishra is a Managing Director, and co-head of Asia Pacific Strategy and India Equity Strategist for Credit Suisse. He has been rated among the best analysts in India by several investor polls. He has been an advisor to several government appointed committees like the Fifteenth Finance Commission and the FRBM Review Committee. He is also part of the CII’s Economic Advisory Council. He worked for Hindustan Unilever and Infosys before he joined Credit Suisse. Neelkanth is a gold medallist from IIT Kanpur, graduating in Computer Science.

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