Mid-year review of economy: Some signs of recovery amid the hurdles

Lack of private investments, muted demand and a spike in Covid numbers may spoil the show

The finance ministry has stopped coming out with the mid-year review of the economy in the winter session of Parliament. This time the winter session itself won't be there.

In the absence of that, let us present Business Standard's half-year assessment of the economy for 2020-21.

Even after the government capital expenditure fell by 38 per cent in the second quarter of the current financial year against a rise of 40 per cent in the first quarter, the economy surprised everyone by contracting 7.5 per cent during July-September. Most analysts had projected more than nine per cent decline. The economy had shrunk an unprecedented 23.9 per cent in the first quarter. As such, it entered a technical recession.

While the fear was that the gross domestic product (GDP) would contract the fastest in the second quarter, as was the case in the previous three months, UK, Spain and Mexico left India behind on this parameter. The UK's economy fell by 9.6 per cent, Spain and Mexico by 8.7 per cent each during July-September quarter.

While agriculture grew in both the quarters, it was manufacturing that made a comeback, rising by 0.6 per cent after four quarters of continuous decline.

Not only did agriculture grow 3.4 per cent in the second quarter--the same as in Q1--farmers also got better prices. At current prices, gross value added (GVA) for the sector grew by 7.7 per cent, translating into a price rise of around 4.3 per cent better than the 2.3 per cent registered during the first quarter of 2020-21.

On manufacturing, experts did not buy the idea of a turnaround since the sector continued to shrink in volume terms during Q2 of 2020-21, down 6.66 per cent during July-September of the current financial year, though much lower than sharp 40.49 per cent fall during the Covid-induced lockdown-affected first quarter.

"There was a minor bump in the manufacturing GVA because of the base effect," said Devendra Pant, chief economist at India Ratings.

He explained that one good reason for this is that manufacturing GVA started declining from the second quarter of 2019-20. Even after a rise in Q2 of the current financial year, the value of manufacturing at Rs 5.79 trillion (at constant prices) in the second quarter of 2020-21 is more or less same as was in the corresponding quarter of 2018-19 and 2017-18. Manufacturing GVA stood at Rs 5.79 trillion in Q2 of 2018-19 and Rs 5.76 trillion in Q2 of 2019-20, Pant explained.

It is too early to say it a turnaround, he suggested.

For a real rebound in manufacturing, the production linked schemes (PLIs) announced by the government have to fructify, experts said.

The Cabinet recently approved a Rs 1.45-trillion package by extending the production-linked incentive (PLI) scheme to 10 more sectors. The policy for what the government calls the champion sectors has been tailored to attract investments, boost domestic manufacturing, enable companies to become part of the global supply chain and generate employment opportunities.

The latest approval was in addition to the already announced Rs 51,311-crore PLI for three sectors. With this, the total incentives under the PLI schemes come to Rs 2 trillion.

It is on manufacturing that the government has pinned its hope for labour-intensive economic growth which it says would be different from jobless growth of past years.

Besides manufacturing, electricity, gas, water supply and other utility services growth also grew by 4.4 per cent in the second quarter.

All the other sectors declined in the second quarter. In fact, financial, real estate and professional services contracted at a higher rate of 8.1 per cent against 5.3 per cent in the previous quarter.

However, bankers see better second half as the economy did not contract as much as was expected in the second quarter.

Ashwani Bhatia, Managing Director (MD), State Bank of India (SBI) said things do not look bad so far. "With the (Q2 GDP) numbers, the double-digit dip in FY21 may not be there and we could see positive growth. This would have a beneficial effect on the credit side. However, much of the credit growth will be seen retail (auto, housing and personal loans) and SME segment," he said.

Besides this sector, government-driven public administration, defence and other services also saw a sharper contraction at 12.2 per cent against 10.3 per cent in the first quarter.

Other sectors such as mining and quarrying, construction, trade, hotels, transport, communication and services related to broadcasting, saw narrower contraction during July-September quarter than Q1. In fact, construction might get a fillip from the government's infrastructure programme after monsoon withdrew in September.

Most of the major segments on the expenditure side showed deceleration in contraction in the second quarter compared to the previous three months but the fall was still high in July-September period.

For instance, private final consumption expenditure, which denotes demand in the economy, was down by 11 per cent in Q2 even as the de-growth was almost one and a half times in Q1. However, demand in the government as measured by the government final consumption expenditure, showed a sharp reversal towards contraction. It turned negative by 22 per cent in July-September against a growth of 16 per cent in Q1.

On the other hand the gross fixed capital formation was down seven per cent in the second quarter, quite lower than 47 per cent in Q1, but still at a high level.

More or less, the same was the story of the government revenues. Either contraction in various components were less severe in Q2 than the first quarter or they turned positive from negative.

This would have widened the Centre's fiscal deficit quite high if the government had not reined in its expenditure. However, the the government severely compressed its expenditure, particularly onthe capital front, in the second quarter (see chart). This resulted in sharp narrowing down of the Centre's revenue and fiscal deficits in the Q2 versus Q1. In fact, its fiscal deficit was just 3.92 per cent in Q2 against 17.39 per cent in the first half. This led to the deficit becoming 10.71 per cent in the first half.

Outlook:

With contraction in GDP standing at around 16 per cent in the first half, there is a wide consensus that the economy would contract in the current financial year. However, there is a wide difference over the rate of contraction. In fact, many believe that the contraction may turn out to be less severe than even RBI's projection of 9.5 per cent.

"The third quarter is likely to be small negative and the fourth quarter will give positive economic growth. The contraction in the entire 2021-22 will be lower than expectations of nine per cent," Niti Aayog vice-chairman Rajiv Kumar said.

Most economists raised their projections for India's economy. For instance, QuantEco Research now projected the GDP to decline 8.3 per cent in the entire financial year against its earlier forecast of 9.5 per cent fall.

CARE Ratings now expected the economy to shrink 7.7-7.9 per cent in the current financial year against its earlier projection of 8.2 per cent fall.

Icra now sensed that the GDP would fall in the range of seven to nine per cent in FY'21 against its earlier estimates of 11 per cent.

But what about uncertainty surrounding Covid?

In fact, chief economic advisor Krishnamurthy Subramanian had stated on the day of the release of the GDP numbers that it is difficult to say whether GDP growth would enter positive territory in the upcoming quarters, given coronavirus-related uncertainty. He said that the government was "cautiously optimistic" as most indicators across sectors have shown improvement in the second quarter of 2020-21 against the first quarter.

However, with gross fixed capital formation still at minus seven per cent and government capex showing a de-growth of 38 per cent, how come the economy would show a turnaround or even gradual recovery?

To be on the fair side, the government capex grew by 129.4 per cent in October, in line with the government's commitment.  However, revenue expenditure declined by 1.3 per cent during the month, despite a sharp increase in the food subsidy.

In fact, the government had spent only 48 per cent of the budget estimates till October. If one adds Rs 25,000 crore over the budget estimates in line with the government statement, the capex accounted for just 45 per cent of the expected outgo in the full year. In absolute terms, the government has Rs 2.40 trillion to spend as capex in the next five months. Though it does not amount much in the context of the size of India's economy, it would

nonetheless give a bit of boost to the economy.

Main problem will come in the way of encouraging private investment. Gross fixed capital formation still showed seven per cent contraction in the second quarter. With this head still just 25.7 per cent of GDP, the country will have to do something to raise it to at least 30 per cent, if not 35 per cent of high growth years.

The Niti Aayog vice-chairman said more measures are required to encourage private investments.

But how can private investments pick up when overall demand is on a declining spree. As cited above private final consumption expenditure was down in the Q2 though at less pace than Q1. It declined 19 per cent in the first half.

In October demand was expected to rise due to festival season. In fact, Society of Indian Automobile Manufacturers (SIAM) did say that passenger vehicles moved to positive with 14.19 per cent growth in domestic sales at 310,294 units in October year-on-year.

However, the Federation of Automobile Dealers Association (FADA) said the passenger vehicle (PV) registrations saw a year-on-year drop of 8.8 per cent to 249,860 units in October 2020. This means that while PVs sales rose from factory to dealers, the sale at the retail level  declined. If the trend continues, it would only lead to inventories which would ultimately lead to less production and less investments.

So far as the fiscal space is concerned to go for at least promised capex by the government is concerned, one should not go by budget estimates. The government compressed expenditures, including capex to rein in its ballooning fiscal deficit which constituted 10.71 per cent of the budget estimates in the first half.

The deficit has widened to 119.7 per cent of budget estimates by October. However, no one expects the government to meet the budget estimates at this juncture. The figure of fiscal deficit at Rs 7.96 trillion for the current financial year does not show the correct picture. Much water has flown since the budget was prepared. The government has gone for extra borrowing which now amounted to Rs 12 trillion. The deficit will be at least this much, according to the government's own calculations, even if one does not factor in funding through national small saving funds

(NSSF) and other means.

If that is the case, the government's fiscal deficit has touched 79.4 per cent of market borrowings. It still has over 20 per cent to spend in the last five months.

Inflation:

If the RBI fails to keep the average inflation rate within the 2-6 per cent band for three consecutive quarters, it would be considered a failure on its part and the central bank would have to 

If April and May imputed inflation rates are taken into account, the RBI failed to keep its mandate to keep the retail price inflation rate within a band of two-six per cent in September itself. However, it 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.

In fact, inflation rose to 7.61 per cent in October too from 7.27 per cent in September. 

While the market expects headline inflation to ease to 4.2 per cent in the fourth quarter from 6.6 per cent in the second quarter as supply bottlenecks in way of food items ease, Motilal Oswal has estimated inflation to remain at 6 per cent in December and January before rising back to 6.5 per cent by March and staying at 6 per cent till September.

If that happens, the monetary policy committee may have to think hard to choose between reviving economic growth and tackling inflation.  

External Account:

Merchandise imports contracted at 41.60 per cent, more than 23.83 per cent fall in merchandise exports and services exports in the first quarter. Similarly services imports contracted at 18.06 per cent, higher than fall in services exports at 10.34 per cent in the quarter. This coupled with other current account receipts and expenditures resulted in current account balance of 1.9 per cent of GDP in the first quarter or $19.8 billion, which is a rarity in India. Factoring in all capital accounts, there was accretion of $19.8 billion in the first quarter of the current financial year against $14 billion  in the same period of 2019-20.  

The second quarter balance of payments data is yet to come, but going by the performance of exports and imports in both merchandise and services sector, it seems current account may still have $12-14 billion in the second quarter, according to estimates of Icra principal economist Aditi Nayar. 

External account outlook:

Merchandise exports rose 5.99 per cent in September, giving a ray of hope that they they  will show a turnaround now after six months of continuous decline. However, exports declined again in October by 5.12 per cent, as fresh wave of Covid-19 hit India's major markets. 

In what could have an adverse impact on India’s exports, the World Trade Organization (WTO) has warned the growth rate in global merchandise trade is likely to slow down during October-December this year as several countries impose fresh lockdowns in light of the second wave of Covid-19.

“... growth in (global trade) is likely to slow in the fourth quarter (October-December, or Q4) as pent-up demand is exhausted and inventory restocking is completed,” the WTO said in its latest report.

Meanwhile, imports continued to show deceleration in their contraction. For instance, those declined 11.53 per cent in October against 19.60 per cent in the previous month. As the economy recovers, imports would gather momentum, narrowing trade deficit and along with services exports and imports , it may convert current account surplus to current account deficit in the coming quarter.

As economic recovery strengthens, Nayar expected the current account surplus to decline substantially in Q3 of FY21 from the previous two quarters. 

The chief economic adivsor recently stated that the economy may have the current account surplus in 2020-21, even if the remaining three quarters do not repeat the $19.8-billion excess amount in current balance in the first quarter.