GDP growth springs a positive surprise: Four implications for FY22

The positives apart, it is clear consumption can't rebound meaningfully without large-scale vaccination; the good news is the rate is likely to improve steadily in the coming months

India’s GDP growth surprised positively in the fourth quarter and financial year 2020-21. Initial estimates by CSO suggested GDP growth at (-) 8 per cent in 2020-21. Accordingly, the imputed growth for the quarter ending March 2021 was (-) 1.1 per cent. As against this, the latest estimates show GDP at (-) 7.3 per cent and (+) 1.6 per cent, respectively during 2021-21 and quarter ending March 2021. Most of the positive surprise was already seen in the last quarter.

What drove this outcome? On the demand side, government spending rose by 28.3 per cent in the last quarter. In fact, the Centre's spending increased from Rs 22.8 trillion during the first nine months of the financial year to Rs 35.1 trillion for the entire financial year, an increase of Rs 12.3 trillion in a single quarter. The Centre's capital spending too increased from Rs 3.08 trillion during the first nine months of the financial year to Rs 4.24 trillion for the entire financial year. This also led to a 10.9 per cent increase in capital formation in the last quarter compared which was (-) 18.9 per cent during the first nine months of the financial year.

On the supply side, too, the last quarter saw a distinct change in growth. For instance, the manufacturing sector is estimated to have seen an increase of 6.9 per cent in the last quarter compared with (-) 12.1 per cent during the first nine months of the financial year. Construction activity rebounded strongly in the fourth quarter with an increase of 14.5 per cent, highest growth rate in the current series (2011-12). Even in April 2021, cement and steel output have seen a large increase and outperformed the other sectors. If the government continues to build roads at the current momentum, this is likely to sustain.

However, consumption spending has been relatively weak. This is more to do with lockdowns impacting demand for services. Out of the total consumption, as much as 50 per cent is driven by the demand for services, and has been impacted adversely. On the other hand, demand for goods has increased as seen in higher imports which increased by 12.3 per cent in the last quarter.

What do these numbers imply for the current financial year, FY22? First, they show that if the economy opens up, the supply side can rebound sharply. Second, the better-than-estimated increase in output also leads to higher tax collections. For instance, indirect tax collections are higher than the revised estimates by as much as 8.5 per cent. Even direct tax collections have shown an upward bias. Third, this gives room to the government to spend to push growth higher. For instance, Centre’s overall expenditure is even higher than the revised estimates. Fourth, government spending is necessary to revive growth when private spending is constrained because of restrictions.

However, the numbers also show that consumption cannot rebound meaningfully till such time a larger proportion of the country is vaccinated. The vaccination rate is likely to see a steady improvement in the coming months. Once this happens, even consumption should rebound meaningfully, particularly when half of consumption is in the form of services. Only once consumption revives will capacity utilization levels increase and thus lead to a virtuous private investment cycle.

Until such time, we would need supportive monetary and fiscal policy. Government has already announced steps to mitigate the impact of the second wave by extending credit linked guarantees to a large number of borrowers. RBI has allowed restructuring and continues to maintain liquidity conditions supportive for revival of growth and meet government need for higher spending. Fiscal spending may have to be accelerated in the coming months to revive growth.

Sameer Narang is chief economist at Bank of Baroda. Views are his own.