How to sustain the economic recovery?
GDP figures for the April to June quarter were slightly lower than consensus estimates, with growth of 20.1%. The most representative measure of economic activity, gross value added (GVA), increased by 18.8 percent. Technically, GDP is calculated by adding indirect tax revenues, net of subsidy payments, to the GVA. The higher GDP growth was driven by high collections of indirect taxes, mainly the GST. Note that while interpreting impressions of growth, it should be kept in mind that they are in a base quarter that had contracted sharply due to lockdowns during the first wave of Covid last year.
In terms of sector activity, the recovery in manufacturing GVA was the most robust, with somewhat subdued mining and electricity growth. Agriculture grew 4.5 percent, with production of grains, pulses and oilseeds at record levels. As might be expected, the service sector remained vulnerable, with activity even lower than expected. The weakest was the composite impression of “trade, hotels, transport and communications”, although even the recovery in construction was weaker than expected, given analyst reports of strong residential demand. Growth in steel and cement production – indicators of construction activity – was also quite robust during the quarter.
On the demand and expenditure side – a mirror of the description of production above – private consumption increased by 19.3 percent (compared to a contraction of 26.2 percent) while investment was 55.3 percent. Public consumption fell 4.8 percent. Net exports (exports minus imports) are generally in deficit, but the gap was much smaller in the first quarter – almost a quarter of the deficit seen last year. This reflects both high exports and moderate imports (mainly a reflection of weak domestic demand, especially lower crude imports).
Global and sector activity levels should be assessed against the corresponding thresholds for the first quarter (pre-pandemic) of 2019-2020. This gives a perspective of how much lower activity levels remain at present, and the quantum of recovery needed to regain the levels. The deepest gaps, understandably, persist in the services segments, the most striking in the construction and “trade +” groups, which are still well below the thresholds. Overall, GVA remains 8% lower, despite the accelerating pace of the recovery.
Beyond the first quarter, all of the high-frequency economic signals we are tracking suggest a strong recovery in July and August. Axis Bank’s composite leading indicator shows activity in August above pre-pandemic levels, and would have been even higher if poor tractor sales in July had not lowered the index reading. Mobility indicators – electricity consumption, e-Way, etc. – suggest continued strong activity in August. The rains, still insufficient in most geographical areas, seem to have recovered recently. However, employment and hiring indicators show mixed signals.
We forecast India’s GDP growth in 2021-2022 of around 9.5-10%, with some uptick as the pace of vaccinations increases and concerns about a third wave, however moderate, begin. to fade. But how can this recovery be sustained or even accelerated over the rest of the year and beyond? The three distinct potential growth drivers – consumption, investment and exports – will need to be effectively supported by policy initiatives over the next two years.
The most direct support will probably be increased public spending. Impressions of the Centre’s income and expenditure in April-July of this year suggest that it has significant leeway to increase its spending.
In addition to the revenue from planned divestments, the swift and efficient implementation of the national monetization plan will open up more fiscal space to increase spending, in particular, on capital spending. These initiatives are well positioned to address short-term demand gaps.
Business balance sheets have improved dramatically during the pandemic. Over-indebtedness has been reduced, operations have become more efficient, and surviving businesses are more competitive and resilient. However, the vast universe of small and medium-sized businesses will take some time to restore their pre-pandemic operational levels. Increasing credit flows from banks, NBFCs and markets, especially to these stressed segments, is a priority, in addition to government spending. Bank lending remained modest from April to July, averaging 6.1 percent growth. It will have to increase.
The external environment offers another opportunity for India to develop. Global stocks are low and, depending on the progress of pandemic easing across geographies, are likely to provide opportunities for Indian exports to fill some of these gaps. While some of the supply disruptions may be transient, this is an opportunity to increase and anchor market share. Yet offshore risks are also increasing.
Global central banks are signaling the imminent normalization of ultra-accommodative monetary policy, and the resulting increased financial sector volatility will have ripple effects in emerging markets, including India. While our economic fundamentals are now much better, sooner or later the RBI will also switch to neutral monetary policy, with a gradual increase in interest rates. For the process to run smoothly, it is crucial to increase India’s growth potential so that the economic recovery does not quickly close the output gap, thus preventing inflationary pressures from rising.
India has a limited window of opportunity to take advantage of the ongoing realignment of global supply chains and gradually integrate manufacturing and services entities. Multiple reform initiatives, tax incentives and others are being implemented. These must be accelerated in coordination with States and using the massive amounts of data now available, to enable an environment of sustained and high growth in the medium term.
This column first appeared in the print edition on September 3, 2021 under the title “A limited window”. The author is Executive Vice President and Chief Economist of Axis Bank. Opinions are personal.