Unrealistic growth forecasts

Substantial shrinkage of GDP is now a certainty

The incoming high-frequency indicators suggest that most forecasters would need to take a fresh look at their projections for gross domestic product (GDP) growth for the current year. There are good reasons to believe that overall economic growth will be sharply in the negative this year, and not hover around the zero per cent mark, which many have predicted. Many sectoral and economy-wide indicators for April have fallen significantly, and as attempts to ease the lockdown get under way, it has already become clear that this will not be an easy or smooth process. For instance, power consumption in April fell by over 20 per cent, compared with the same period last year, while the sale of the most consumed fuel diesel declined by over 55 per cent. The Purchasing Managers’ Index also suggests that economic activity has contracted significantly. A sharply negative GDP number for the first quarter should therefore be taken as a given. This would lead to significantly negative GDP growth for the year as a whole because of obvious reasons.

The consumption slowdown will not end quickly when so many are unemployed or have left the job market, which is partly being reflected by the reverse migration of labour. Reduced consumption translates into spare capacity, which will affect private investment. The gap created by these developments could be filled by more production for exports or higher public spending to support either consumption or investment, or both. However, higher exports are unlikely because global demand is set to shrink as well. It is now also clear that the government is not going to come up with a large spending package to revive the economy or alleviate economic distress. This has been confirmed through comments made by the chief economic adviser and the revised borrowing target for the current year.

The ostensible reason is lack of resources and the dangers to an emerging market economy if it is seen to be fiscally irresponsible, or resorting to printing money to fund government expenditure. The risks could come from inflation, sovereign ratings downgrades, an outflow of portfolio money, and currency weakness. Such risks do exist, but whether they should be the primary focus of attention just now will be an academic debate because it is now clear that the government is not going to open the tap. All that the over 50 per cent increase in the borrowing limit announced last week signals is a neutralisation of tax and disinvestment revenue shortfalls, using the opportunity provided by excess liquidity in the money market. 

Since this comes at a time when state governments too have suffered staggering revenue shortfalls, going up to 90 per cent in April for Telangana and Delhi and with broadly comparable numbers elsewhere, what is clear is that they, accounting for about 60 per cent of government spending, will have to shrink their operations. They will also need to divert more resources to fight the pandemic. The general government deficit may go up, but government spending in totality may well shrink. In other words, no fiscal stimulus. Therefore, with lower private consumption and investment demand, sluggish exports, and a decline in government expenditure, why should one not expect a substantial shrinkage in GDP this year?