New Delhi: The surprising resilience shown by the manufacturing sector that restricted the GDP contraction to just 7.5 percent in the September quarter could be the result of a massive purge of costs such as the cost of employees by corporations and businesses, which could create a potential headwind in the future, SBI economists wrote on Saturday.
India’s GDP growth in July-September (second quarter of fiscal 2020-21) showed surprising resilience with a contraction of just 7.5 percent in real terms, while market consensus was higher, Soumya wrote. Kanti Ghosh, Group Chief Economic Advisor, State Bank of India, at Ecowrap.
With the improvement in manufacturing, due to the lifting of the lockdown measures, the contraction of GDP has slowed significantly. The agricultural sector continued to perform well with growth of 3.4%. Services remained in negative territory, although the decline was contained as trade, hotels, transportation, communications and services related to broadcasting showed recovery.
“The most staggering number is the positive growth in the second quarter of manufacturing. Despite being the sector most affected in the first quarter (due to the shutdown), it is quite puzzling how manufacturing changed,” he wrote in the edition of Ecowrap.
Manufacturing PII growth and manufacturing GVA are highly correlated (almost over 0.90) and this correlation collapsed in the second quarter when manufacturing PII declined 6.7% (July-September average) while manufacturing GVA grew 0.6%.
“We believe a possible reason for this could be the stellar corporate GVA numbers in the second quarter due to a massive cost purge. Additionally, we are looking at small businesses, with turnover up to ₹500 crore, they are more aggressive in cutting costs, showing a reduction in employee cost by 10-12 percent, “said Ecowrap.
This, he said, could create a potential headwind in the future in terms of a drag on consumption. “Additionally, there is evidence of inventory build-up that could act as a drag on future growth in manufacturing.”
Interestingly, government consumer spending has also plummeted in the second quarter, which is difficult to explain as these spending are often pro-cyclical, Ecowrap said.
The SBI economist said that the absolute numbers of the services sector in Q2FY21 is ₹17.19 crore lakh, while in the third quarter of fiscal year 20 it was ₹17.35 crore lakh, only ₹15,000 crore less. This indicates that the service sector has reached the pre-COVID-19 level.
“Is it due to behavioral changes during the pandemic, such as mass transportation of goods once the economy opened up and a massive push for communication and broadcasting with people working primarily from home?” I ask.
One good thing is that investment demand has improved with the resumption of stalled COVID-19-induced projects. However, uneven growth in all sectors is reflected in the domestic demand figures, which show a modest recovery on a sequential basis.
The fall in imports and the continued contraction of investment suggest poor internal absorption and intermediate demand.
“The second quarter GDP reading suggests that the output gap has not been corrected to the point that it will be a concern over demand inflation. Also, inflationary pressure on agricultural products despite output expansion has further limited the policy option.
“The policy option must move towards a continued relaxation of the mobility of goods and give a massive boost to the construction and infrastructure sector. It should focus more on increasing the ease of doing business and the participation of the private sector,” he said.
The economist said the recent measures the government has taken are heading in the right direction and should be followed to further boost economic momentum.
The economic momentum, as indicated by the Business Activity Index, shows a steady improvement in the last week after a temporary slump seen during the week of Diwali due to the holidays. The SBI Business Activity Index has risen to the highest level since March 9.
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