India staring at a GDP contraction of 10%, says former finance secretary

Lockdown 1 and 2 turned out to be extremely severe, though agriculture and government expenditure, which constitute about 25% of GVA, remained almost unaffected, writes Subhash Chandra Garg

Former finance and economic affairs secretary Subhash Chandra Garg on Tuesday said that India is staring at a GDP contraction of 10 per cent in FY21 and that a well-targeted stimulus could have saved businesses and workers. Garg in a blog titled, "Lockdown, Stimulus, and Growth: Is India Staring at a Large GDP Contraction in 2020-21?" said, "a close examination of Rs 21 trillion economic stimulus package suggests that fiscal measures amount to only Rs 1.45 trillion (or about .7% of GDP). A lot of hopes were raised when the Prime Minister announced Rs 20 trillion package. However, in the end, the government chose not to rock the fiscal boat." 

Here is the full text of the blog summary

India was not in the pink of economic health in 2019-20. First Estimates of 2019-20 announced on 29th May confirmed this. India grew barely by 4% for the year which happens to the lowest growth rate in last 11 years.

In one of the most impulsive decisions taken, India was placed under a 21- day lockdown virtually without any notice or warning on 24th March, 2020. 135 crore Indians got locked-up in their homes or wherever they were stranded on the evening of 24th March. Millions of businesses, producing goods and services, barring the ‘essential goods’ were locked-down. The lockdown rendered over 10 crore workers jobless overnight; many of them started walking hundreds of kilometres to the ‘safety’ of their rural homes. India’s lockdown strategy was faulty. The lockdown was imposed under a naive belief that India would be able to eliminate Covid-19 from the face of India in three weeks’ time. India decided to use the brahmastra- total economic and human lockdown- on the entire country when only a tiny part was infected.

Lockdown 1 and 2 (entire month of April) turned out to be extremely severe, though agriculture and government expenditure, which constitute about 25% of GVA, remained almost unaffected. As 70% of the remaining economy remained shuttered, about 50% of monthly GDP output was lost in April. Lockdown 3 (first half of May) opened up India a little bit. Lockdown 4 (second half of May) allowed many productive activities to commence. Yet, India would lose about 40% of monthly output in May as well.

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Following Prime Minister’s announcement of a Rs 20 trillion stimulus package on 12th May, finance minister revealed the package in five instalments over next five days (13-17th May). This package was costed at Rs 20.97 trillion or 21 trillion on the final day of announcements. It included March 26 package and also various liquidity measures taken by the RBI. It also included some releases made from existing budget for supporting health infrastructure and for meeting disaster relief arrangements.

The 21-trillion package is a mish-mash of five kinds of interventions- liquidity measures by the RBI, liquidity measures by the government, fiscal support measures by the government, credit support to businesses and other measures in the nature of intent of future investments and expenditures to be incurred by others.

While quite late compared to other Central Banks, RBI was off the block in the last week of March to announce a slew of liquidity measures which, as claimed by the Finance Minister in her presentations, added up to Rs 8.1 trillion. RBI liquidity measures were aimed at encouraging, even forcing, the banks to lend and to buy corporate bonds. As these measures did not take into account massive credit risk averseness of banking system and absolute inability of the businesses to take credit in the lockdown, the liquidity bazooka proved a damp squib. The banks availed very little of the liquidity measures offered by RBI. On the contrary, they increased their Reverse Repo deposits with RBI to unprecedented levels of Rs 7.5 trillion (higher than post demonetisation liquidity).

Finance Minister Nirmala Sitharaman during the last tranche of her Covid-19 relief measures| Photo: PIB

The government followed up with its own set of liquidity measures totalling to Rs 4.45 trillion. These were based on guarantee support from the government and additional liquidity by the Central Financial Institutions like NABARD. All these measures are riddled with many ifs and buts and rely on unfounded hopes of an unprecedented performance by the financial institutions. MSMEs credit flow, following normal growth and suasion of government might lead to credit flows of about Rs 1.5 trillion. Rest of the liquidity measures may remain on paper.

A fiscal stimulus measure should usually result into expansion of government expenditure. A close examination of Rs 21 trillion economic stimulus package suggests that fiscal measures amount to only Rs 1.45 trillion (or about .7% of GDP). Lot of hopes were raised when the Prime Minister announced Rs 20 trillion package. However, in the end, the government chose not to rock the fiscal boat.

There were three credit stimulus measures of Rs 3.25 trillion in the Atmanirbhar Bharat package- Rs 3 trillion credit facility for standard MSMEs, a Rs 20,000 crore credit facility for non-performing MSMEs and a Rs 5,000 crore credit facility for street vendors. Total outstanding credit to Micro and Small Enterprises is about Rs 15 trillion. A million-dollar question is whether the banks would really lend to the MSEs. Credit policy is the responsibility of RBI. It is strange that credit package came from the government. The MSME credit package relies on government guarantees. It is unlikely that the private sector banks would fall for this. It is only the PSBs which might deliver something under this package. The directed credit with the bait of guarantee might drive the last nail in the coffin of PSBs.

PM Modi during a review meeting on education sector. (PIB)

The remaining package totalling Rs 3.8 trillion comprising three types of interventions- intent to invest in agriculture infrastructure and MSMEs, some measures already part of the budget and the measures which parties other than the Government of India were expected to carryout. Five measures totalling Rs 1.295 trillion constituted government’s intent to make investment in agriculture and allied sector infrastructure, including a Rs 1 trillion Agri Infrastructure Fund to build farm-gate infrastructure. For MSMEs, the Government announced a Rs 50,000 crore Fund of Funds. There are two schemes- Matsya Sampada Yojana and Viability Gap Funding Scheme for which their lifetime outlays were announced as part of the stimulus package.

The fiscal stimulus measures announced would at best cost government Rs 1.5 trillion. The government is attempting to save more amount than this by controlling expenditures. The government may end the year 2020-21 without expanding expenditures at all. A Rs 21 trillion stimulus delivered without costing anything to the government!

GDP matters as all the three factors of production- workers, capital and government- receive their income- wages, profits and taxes- from the value added produced in businesses. The task of assessing likely 2020-21 GDP performance is indeed not only a difficult exercise but there are also lot of unknowns.

The Gross Value Added (GVA) from the supply side falls broadly in three groups. First group of agriculture and allied sector makes up about 15% of India’s GVA and government services, which also amounts to about 15% of GVA, have largely remained unaffected and are likely to see no contraction in 2020-21. Industrial goods, mining goods, construction and utilities together form about 40% of GVA. Barring a few essential goods and some continuous processing industries and utilities almost every business in this group was down and out in April. For the year as a whole, this group contributing about 40% of India’s GDP is expected to suffer about 15-20% loss of GVA. Remaining services- trade and commerce, transportation, financial, and hospitality etc.- makes up another about 40% of India’s GVA. As trade and commerce and financial services make up about 2/3rd of the services in this group and these are likely to return normal performance for the year and transportation and hospitality services would be severely disrupted, it will be fair to estimate that about 8-10% of the GVA in this group would get lost in the year 2020-21. Putting the sum of parts together, supply side dynamics seem to suggest that India’s GDP will contract by about 10-12% for the financial year as a whole. 

There are three primary contributors to the GDP from demand/expenditure side- private consumption, government consumption and investment which contribute approximately 58%, 13% and 29% of GDP. It looks likely that capital formation growth would decline by 15-20% in the current year. Assuming that the Government would be able to keep its expenditure at BE levels, the government expenditure which is about 13-14% of GDP should grow by about 10%.  Private consumption has two major parts- essential consumption and discretionary consumption. Essential consumption- food, medical, gas, water and electricity etc.- makes up about 70% of the total consumption or about 40% of GDP. Discretionary expenditure- travel, entertainment, restaurants etc.- makes up for about 20% of GDP. The essential consumption may stay flat during the year. Discretionary expenditure which suffered substantial setback in last two months and may not achieve normal level during the entire year may make discretionary expenditure contract by about 25-30% for the year as a whole. Putting all these together, India is likely to see about 8-12% contraction from the demand side as well.

There are three real factors of production- labour, capital and government. They share the GDP income. They benefit when GDP grows. Their incomes enlarge, may be in varying proportions, when GDP grows. They also suffer when GDP contracts. About 65% of GDP income accrues to workers- the largest factor of production and the largest factor of consumption. Roughly about 20% of India’s GDP services the capital. Remaining 15% is the share of governments. The state of play suggests that the government would bear about 25% of the loss of GDP income of Rs 20 trillion i.e. a total loss of about Rs 5 trillion. The capital may get away with a loss of not more than 10% of total income loss i.e. about Rs 1 trillion. The workers would bear the rest of it- a whopping loss of about Rs 14-15 trillion in the year 2020-21.

It is certain that India’s GDP will contract after 40 years in 2020-21. It also appears fairly certain that this would be a very large contraction- of about 10% of GDP or loss of about Rs 20 trillion of income. The nominal fiscal package of Rs 21 trillion is actually of only Rs 1.4-1.5 trillion or about 0.7% of GDP. While the strategy of Government may succeed in not allowing fiscal deficit to expand on account of expenditure stimulus, but the big hole on revenue side and off-budget expenditures will make central government fiscal expenditure go beyond 7% in 2020-21. Every factor of production will suffer- the workers most. 2020-21 will go down in the history of India as the year when India got waylaid from its story of 3 decadal outstanding growth.