Updated: September 1, 2020 7:10:53 am
Migrant workers return to New Delhi from parts of Uttar Pradesh on August 8, 2020 (Photo Express: Praveen Khanna).
Although most people expected India’s GDP to show a substantial contraction when the Ministry of Statistics and Program Implementation (MoSPI) released the data for the first quarter (April, May, June) of the current financial year on Monday, the general consensus was that the decrease would not exceed 20%. It turns out that the GDP contracted 24% percent in the first quarter.
In other words, the total value of goods and services produced in India in April, May and June this year is 24% less than the total value of goods and services produced in India in the same three months last year.
How Graph 2 This is confirmed by almost all the main indicators of growth in the economy, be it cement production or steel consumption, show a deep contraction. Even the total of telephone subscribers experienced a contraction this quarter.
What’s worse is that, due to widespread crashes, the quality of the data is suboptimal, and most observers expect this number to worsen when revised in due course.
Graph 1: History of India’s GDP since economic liberalization. Source: McKinsey and Express Research Group.
Graph 2: Percentage variation of the key indicators. Source: Ministry of Statistics and Program Implementation.
What is the biggest implication?
With GDP contracting more than most observers expected, it is now believed that full-year GDP could worsen as well. A fairly conservative estimate would be a 7% contraction for the entire financial year.
Figure 1 puts this in perspective. Since economic liberalization in the early 1990s, the Indian economy has recorded an average GDP growth of 7% each year. This year, it is likely to turn into a turtle and shrink by 7%.
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In terms of gross value added (a proxy for production and income) of the different sectors of the economy, the data shows that except for agriculture, where GVA grew by 3.4%, all other sectors of the economy saw drop your income.
The most affected were construction (–50%), commerce, hotels and other services (–47%), manufacturing (–39%) and mining (–23%). It is important to note that these are the sectors that generate the most new jobs in the country. In a scenario in which each of these sectors is contracting so sharply, that is, their production and income are falling, more and more people would lose jobs (decrease in employment) or would not get one (increase in unemployment ).
Graph 3; source: McKinsey
What Causes GDP Contraction? Why hasn’t the government been able to stop it?
In any economy, the total demand for goods and services, that is, GDP, is generated from one of the four growth engines.
The most important driver is consumer demand from individuals like you. Let’s call it C, and in the Indian economy, this accounted for 56.4% of all GDP before this quarter.
The second most important driver is the demand generated by private sector companies. Let’s call it me, and this accounted for 32% of all GDP in India.
The third driver is the demand for goods and services generated by the government. Let’s call it G, and it accounted for 11% of India’s GDP.
The last driver is net demand over GDP after subtracting imports from India’s exports. Let’s call it NX. In the case of India, it is the smallest engine, and since India typically imports more than it exports, its effect is negative on GDP.
Then total GDP = C + I + G + NX
Now look Table 4. It shows what has happened to each of the engines in the first quarter.
Figure 4: Growth engines fail. Source: MoSPI and Express Research GrOup
Private consumption, the biggest engine driving the Indian economy, has fallen 27%. In monetary terms, the drop is 5.31.803 crore compared to the same quarter last year.
The second biggest driver, corporate investment, has fallen even further: it’s half what it was in the same quarter last year. In monetary terms, the contraction is 5.33,003 million rupees.
So the two biggest engines, which accounted for more than 88% of India’s total GDP, experienced a massive contraction in the first quarter.
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The NX or Net Export Demand has turned positive in this first quarter as India’s imports have plummeted more than its exports. While on paper this provides a boost to overall GDP, it also points to an economy where economic activity has slumped.
That brings us to the ultimate growth engine: government. As the data shows, government spending increased by 16%, but this was not close enough to offset the loss of demand (energy) in other (engine) sectors of the economy.
Looking at the absolute numbers gives a clearer picture. When the demand for C and I fell by Rs 10,64,803 crore, government spending increased by just Rs 68,387 crore. In other words, government spending increased but was so meager that it could only cover 6% of the total drop in demand experienced by individuals and businesses.
The net result is that, while on paper the share of public spending in GDP has increased from 11% to 18%, the reality is that overall GDP has decreased by 24%. It is the lowest level of absolute GDP that makes the government seem like a bigger growth engine than it is.
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Where is the exit?
When incomes fall sharply, individuals reduce consumption. When private consumption falls dramatically, companies stop investing. Since both are voluntary decisions, there is no way to force people to spend more and / or coerce companies to invest more in the current scenario.
The same logic also applies to exports and imports.
Under the circumstances, there is only one engine that can drive GDP and that is the government (G). Only when the government spends more, either building roads and bridges and paying salaries or handing out money directly, will the economy be able to revive itself in the short and medium term. If the government doesn’t spend enough, it will take a long time for the economy to recover.
Read | Only the production of the agricultural sector experiences growth, exceeds the general GDP for the third consecutive quarter
What prevents the government from spending more?
Even before the Covid crisis, government finances were overextended. In other words, he was not just borrowing, but borrowing more than he should have. As a result, you don’t have that much money today.
You will need to think of some innovative solutions to generate resources. Chart 4 from the McKinsey Global Institute provides ways in which the government can raise an additional 3.5% of GDP.
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