Economy to recover in 2021, but output may take another year to regain loss

While inflation is likely to moderate, fiscal deficit is clearly the pain point

There is broad consensus among experts that the economy will revert to marginal growth in the first quarter of the coming calendar year 2021, though opinions are varied on whether the economy will continue to contract or expand to a small extent in the fourth quarter of Calendar 2020.

That the economy is on a recovery path was substantiated by a better-than-expected performance in the third quarter of Calendar 2020 (second quarter of FY21). The economy shrank by 7.5 per cent in that three-month period while many predicted a fall of at least nine per cent. The second quarter of Calendar 2020 saw an unprecedented decline in gross domestic product (GDP) by 23.9 per cent due to Covid-induced lockdowns that were introduced in the last week of March 2020. Signs of slowdown were visible from the start of 2020, with GDP growth at 3.1 per cent in the first quarter of the Calendar year (fourth quarter of FY20), a low not seen in more than 17 years till then.

The Reserve Bank of India (RBI) now expected the economy to grow moderately at 0.1 per cent by the end of the fourth quarter of 2020. However, India Ratings projected the economy to contract 0.8 per cent.

Both of them, however, forecast economic expansion within the fourth quarter. While RBI expected the GDP to grow 0.7 per cent in the first quarter of 2021, Ind-Ra pegged the expansion at 0.3 per cent.

The central bank now believes that GDP will grow by an unparalleled 21.9 per cent in the second quarter of Calendar 2021 largely because of the base effect.

Most projections for years are available on the financial year (April to March) basis. RBI now projected the economy to contract at a lower rate of 7.5 per cent against its earlier estimates of 9.5 per cent. Ind-Ra also drastically brought down its expectations of GDP contraction to 7.8 per cent in FY21 from its earlier projection of 11.8 per cent.

Ind-Ra expected the economy to recover to a growth of 9.6 per cent in 2021-22.

However, experts do talk about the uncertainty that could come due to yet-to-be-controlled Covid-19, even as they believe that economic players are now better equipped to deal with this crisis.

"Although the headwinds emanating from Covid-19-related challenges are unlikely to go away till mass vaccination becomes a reality, perhaps the economic agents and economic activities not only have learnt to live with it, but also are adjusting swiftly to the post Covid-19 world," said Ind-Ra principal economist Sunil Kumar Sinha.

Projections by the two most important global agencies -- International Monetary Fund and World Bank-- are yet to be released after July-September GDP numbers came out.

However, the Organization for Economic Co-operation and Development (OECD) has slightly raised the prospects of India’s economy, pegging contraction at 9.9 per cent during the current financial year, against 10.2 per cent projected earlier. It forecast that the economy would rebound to 8 per cent in the next fiscal.

While the rebound of the economy next financial year is a foregone conclusion, the important thing is whether the economy would regain its lost output or not.

For instance, if OECD's projections are taken for consideration, the GDP at constant prices would decline to Rs 131.23 trillion in 2020-21 from Rs 145.65 trillion in 2019-20. It would rise to Rs 141.73 trillion in 2021-22, but it would still be less than the GDP of 2019-20.

Retail price inflation:

The consumer price index-based inflation rate may not remain as high as it was in 2020, but might hover around five per cent for a significant part of the coming year. And save for March, it never fell below six per cent, which is the upper range of the mandate given to the Reserve Bank of India's monetary policy committee (MPC), till November in the current calendar year. In March too, the rate was quite close to six per cent, coming in at 5.84 per cent. In fact, if imputed inflation for April and May is taken into account, MPC has failed in its task of not allowing the average inflation rate to cross six per cent in the three consecutive quarters. However, the committee did not consider April and May inflation rates as those were imputed numbers. Imputation means prices of some groups are taken as substitutes of those of similar segments (and assorted accordingly) for which information is not available. This happened as the country was under a government-imposed lockdown in April and May.

However, the inflation rate fell in November over that of the previous month for the first time in five months. It declined to 6.93 per cent in November from 7.61 per cent in the previous month. The food inflation rate too came down from as high as 11 per cent in October to 9.43 per cent in November. Going forward, inflation is likely to switch gears with the food part coming down and non-food items seeing higher inflation as the economy recovers.

Madan Sabnavis, chief economist at CARE Ratings, said the inflation rate will be above five per cent throughout the year for certain. "In fact, it may average at around 5.5-6 per cent, driven more by the demand side of non-food products. Once the economy starts growing, there would be demand pull factors building up," he said. .

Soumya Kanti Ghosh, group chief economic advisor at State Bank of India, believes CPI may average 4.7 per cent in the next financial year. "It won't come down below five per cent in the first half. Food inflation will go down but services inflation will go up," he said.

Fiscal Deficit:

While the Centre's fiscal deficit is likely to double from the Budget Estimates of 3.5 per cent of GDP for the current financial year, it may remain more than the fiscal consolidation road map for the next financial year as well.

The medium-term fiscal policy-cum-strategy statement, tabled in Parliament along with the Budget 2020-21, put fiscal deficit at 3.3 per cent for FY22. This is not likely to be met due to demand from various sectors that need to be perked up and the requirements of the health sector.

In fact, industry and economists have urged Finance Minister Nirmala Sitharaman to relax fiscal consolidation for a few more years.

Aditi Nayar, principal economist at Icra, said a target of five per cent of GDP may be considered for the Centre's fiscal deficit either as a point estimate or the mid-point of a range.

Sabnavis estimated the fiscal deficit at 5-6 per cent for the next fiscal year and said fiscal consolidation should be deferred for the next two years.

Devendra Pant, chief economist at India Ratings, said returning to the fiscal consolidation path, as given in the Budget papers for the next two years, would not be possible. The government may have to continue to perk up some sectors, he said.

So far as the current financial year is concerned, the deficit breached the Budget Estimates in absolute terms by 19.7 per cent by October itself.

Sabnavis said the deficit would be around nine per cent in FY21. If the government cuts wasteful expenditure as it is trying now, the deficit would at most fall to eight per cent, not less than that, he said.

Nayar said the deficit would be Rs 14.5 trillion or 7.7 per cent of GDP, while Sinha of India Ratings said it would touch 7 per cent.

Current Account Balance:

Unlike an expected current account surplus in 2020, the next calendar year is all set to witness a current account deficit, though not at an alarming level.

Sabnavis said that the surplus will probably remain till December. After that the current account will have a deficit, he said.

"However, it will be nothing very very dangerous. It may be around one per cent of GDP for the calander year 2021 and 1-1.5 per cent of GDP for 2021-22," Sabnavis projected.  

Nayar pegged the deficit at 0.8 per cent of GDP for 2021-22.

The country's current account balance recorded a marginal surplus of $0.6 billion or 0.1 per cent of GDP in the first quarter of 2020 as against a deficit of $4.6 billion, or 0.7 per cent of GDP in the corresponding period of 2019, and $2.6 billion deficit or 0.4 per cent of GDP in the preceding quarter or fourth quarter of 2019.

The surplus in the current account was primarily on account of a lower trade deficit at $35 billion and a sharp rise in net services receipts at $35.6 billion over the corresponding period of last year. Net services receipts rose on the back of higher net earnings from computer and travel services on a year-on-year basis.

In the second quarter of 2020, merchandise imports shrank by 41.60 per cent, more than the 23.83 per cent drop in merchant exports. Similarly services imports contracted by 18.06 per cent, higher than the 10.34 per cent fall in services exports during the quarter. This, coupled with other current account receipts and expenditures, resulted in a current account surplus of $19.8 billion or 1.9 per cent of GDP.

The third quarter balance of payments data is yet to come, but going by the performance of exports and imports in both, the merchandise and services sectors, it seems current account may still have  a surplus of $12-14 billion, according to Nayar.

As economic recovery strengthens, Nayar expected the current account surplus to decline substantially in the fourth quarter of 2020 from the previous two quarters.