Indian GDP to contract by 7-9% in FY21; Q2 numbers a positive surprise

Despite the entirely expected, yet unpalatable confirmation that India indeed entered into a recession in H1 FY2021, the GDP data for Q2 FY2021 did contain a positive surprise. The pace of GDP contraction narrowed sharply to 7.5 per cent in the just-concluded quarter, from the deep 23.9 per cent in Q1 FY2021 that was riddled with the lockdowns. The initial data for Q2 FY2021 revealed a milder contraction than our forecast of 9.5 per cent, primarily driven by a better-than-expected performance of manufacturing, electricity and construction, and to a smaller extent, agriculture. 
 

While manufacturing volumes continued to contract, the GVA of this sector eked out a marginal 0.6 per cent growth in Q2 FY2021, on the back of aggressive cost-cutting measures, a pared down wage bill and benign raw material costs. 
 

Additionally, the robust recovery in the performance of key inputs of construction such as cement and steel, and healthy Central Government awards in roads and railways during Q2 FY2021, narrowed the contraction in the GVA of this sector to 8.6 per cent in Q2 FY2021, despite the YoY contraction in the actual capital spending of the central and state governments. 

 

Despite the base effect, agriculture and allied activities maintained a steady growth of 3.4 per cent in Q2 FY2021, benefitting from the healthy kharif season that was underway, as well as a robust performance of the fishery sector.
 

In contrast, the services sector as a whole recorded a deeper contraction in Q2 FY2021 than what we had estimated, confirming the view that the contact-intensive portions of the economy will experience a delayed and difficult recovery.

Moreover, the pace of contraction of two sub-sectors, financial, real estate and professional services, and public administration, defence and other services, actually worsened in Q2 FY2021 relative to the previous quarter, serving as a reminder that the path out of the pandemic may not be universally painless.

 

In terms of the components of demand, unsurprisingly, the pace of contraction in private final consumption expenditure narrowed sharply in Q2 FY2021, benefitting from the pent-up demand related to the lockdown quarter. 
 

Equally unsurprisingly, the loss of momentum in government spending in Q2 FY2021, led to a 22.2 per cent contraction in government final consumption expenditure (GFCE). As a result, this component displayed the ignominy of posting the worst performance on the expenditure-side in Q2 FY2021, after being the best performer with a 16.4 per cent expansion in Q1 FY2021. Excluding GFCE, the contraction in the balance GDP narrowed to a modest 5.4 per cent in Q2 FY2021 from the substantial 29.3 per cent in the previous quarter.
 

However, the considerably compression in the contraction of gross fixed capital formation to 7.3 per cent in Q2 FY2021 from 47.1 per cent in the previous quarter has come as a surprise, even though it mirrors the trend in capital goods. It is likely that his component may subsequently undergo a considerable revision, when additional data becomes available. 
 

This brings us to a crucial question, is India out of the recession already?
 

The base effects and changes in the number of working days in October-November 2020 related to the shift in the festive dates, are currently obscuring an analysis of the strength and durability of the improvement in demand that is underway in Q3 FY2021. Looking ahead, rising commodity prices and the initiation of salary hikes in Q3 FY2021, may offset the impact of the expected volume normalization, casting some uncertainty on the sustainability of growth in the manufacturing GVA in the remainder of the year.
 

We continue to highlight that the extent of the recovery in the performance of the informal sectors in Q2 FY2021 remains unclear, and caution that trends in the same may not be getting fully reflected in the GDP data, given the lack of adequate proxies to evaluate the less formal sectors.
 

On balance, we now expect Indian GDP to post a contraction of 7-9 per cent in FY2021, milder than our previous projection of 11.0 per cent. However, the possibility that a rise in Covid-19 infections may necessitate the re-imposition of fresh restrictions, causing the momentum of the recovery to falter, remains a risk.

The writer is the Principal Economist at ICRA