All You Wanted to Know About India’s Economic Contraction This Year

The National Statistical Office (NSO) published the first advance estimates of the gross domestic product (GDP) for 2020-21, the current financial year, yesterday.

The NSO expects the Indian GDP to contract by 7.7% to Rs 134.4 lakh crore during the year. The GDP is a measure of the economic size of a country and thus, GDP growth/contraction is a measure of economic growth/contraction. Data from the Centre for Monitoring Indian Economy (CMIE) shows that this is the worst performance of the Indian economy since 1951-52.

Let’s take a look at this pointwise.

1) This is the fifth time the Indian economy will contract during the course of a financial year. The last time the Indian economy contracted was in 1979-80, when it contracted by 5.2%, due to the second oil shock.

Before 1979-80, the Indian economy had contracted on three occasions during the course of a year. This was in 1957-58, 1966-67 and 1972-73, with the economy contracting by 0.4%, 0.1% and 0.6%, respectively.


Source: Centre for Monitoring Indian Economy.

Hence, in the years after independence, the Indian economy has seen two serious economic contractions, the current financial year is the second one.

2) One way the GDP of any country is estimated is by summing the private consumption expenditure, investment, government expenditure and net exports (exports minus imports), during the year.

The government expenditure has always been a small part of the Indian economy. It was at 5.6% of the GDP in 1950-51. It has gradually been going up since then. In 2020-21, it formed 13% of the GDP, the highest it has ever been. This tells you the times that we are living in. The government expenditure as a part of the GDP has been going up since 2013-14, when it was at 10% of the GDP. Hence, the government has had to spend more and more money to keep the growth going over the last five to six years.

Given this, while the spread of the covid-pandemic has created a massive economic mess this year, the Indian economy has been slowing down for a while now. This is the broader message that we shouldn’t miss out on, in all the song and dance around the economic recovery.

3) If we leave out the government expenditure from the overall GDP figure, what we are left with is the non-government GDP. This is expected to contract by 9.5% during this year, the worst since 1951-52. What this also tells us is that the non-government part of the economy which will form 87% of the economy in 2020-21, is in a bigger mess than the overall economy.

4) This isn’t surprising given that investment in the economy is expected to contract by 14.5% during the year. What does this mean? It first means that for all the positivity that  the corporates like to maintain in the public domain about the so-called India growth story, they clearly aren’t betting much money on it.

As the new twist to the old proverb goes, the proof is in the pudding. During the period October to December, the new investment projects announced, by value, fell by 88%, and the investment projects completed, by value, fell by 72%. This is a period when corporates were talking up the economic recovery big time.

5) It is investments into the economy that create jobs. When the investments are contracting there is clearly a problem on that front. It also leads to the question of what happens to India’s so-called demographic dividend. One fallout of a lack of jobs has been the falling labour force participation rate, especially among women, which in December 2020 stood at just 9.28%. This is a trend that has been prevalent for five years now and Covid has only accelerated it. More and more women are opting out of the workforce.

6) Getting back to corporates. The profitability of Indian corporates went through the roof between July and September. This when the broader economy was contracting. How did this happen? The corporates managed to push up profits by driving down costs, in particular employee cost and raw material cost. While this is corporates acting rationally, it hurts the overall economy.

This means that incomes of those working for corporates and those dealing with them (their suppliers/contractors etc.) have come down. Net net this will hurt the overall economy and will eventually hurt the corporates as well, because there is only so much cost-cutting you can do. Ultimately, only higher sales can drive higher profits and for that the incomes of people need to grow.

7) It is hardly surprising that investments are expected to contract during the year, given that private consumption expenditure, the biggest part of the Indian economy, is expected to contract by 9.5% during the year. Ultimately, corporate investment leads to production of goods and services that people buy and consume, and things on the whole don’t look too good on this front.

In fact, even in 2019-20, the last financial year, the private consumption expenditure had grown by just 5.3%, the worst in close to a decade. This again tells us that while covid has been terrible for the economy, things weren’t exactly hunky dory before that.

8) The final entry into the GDP number is net exports. Typically, this tends to be negative in the Indian case, simply because our imports are much more than our exports. But this year that is not the case with net exports being in positive territory, the first time in four decades. This has added to the overall GDP. But is this a good thing? The exports this year are expected to contract by 8.3% to Rs 25.8 lakh crore. In comparison, the imports are expected to contract much more by 20.5% to Rs 24.8 lakh crore.

What does this tell us? It tells us that the demand for Indian goods in foreign countries has fallen because of covid. At the same time, the contraction of Indian imports shows a massive collapse of demand in India. Non-oil, non-gold, non-silver goods imports, are a very good indicator of consumer demand and these are down 25.3% between April and November this year, though the situation has been improving month on month.

9) There is another way of measuring the GDP and that is by looking at the value added by various sectors. If we were to consider this, agriculture growth during the year remains sturdy at 3.4%. While, this is good news on the whole, it doesn’t do anything to change the fact that close to 43-44% of the workforce is employed in agriculture and contributes just 15% of the economic output.

Come what may, people need to move away from agriculture into professions which add more value to the economy. This hasn’t been happening at the pace it should.

10) The non-agriculture part of the economy, which will form around 85% of the economy this year, is expected to contract by 9.4%, This clearly isn’t good news.

11) Industry is expected to contract by 9.6%. Within industry, manufacturing and construction are expected to contract by 9.4% and 12.6%, respectively. The construction sector is a big creator of jobs, especially jobs which can get people to move away from agriculture. With the sector contracting, the importance of agriculture in the economy has gone up.

12) The services sector is expected to contract by 8.8%. Within this, trade, hotels, transport, storage and communication (all lumped into one, don’t ask me why) is expected to contract by 21.4%. This isn’t surprising given that people continue to avoid hotels and travelling, thanks to the fear of the covid pandemic.

13) The GDP during 2020-21 is expected to be at Rs 134.4 lakh crore.  The GDP during 2019-20 was at Rs 145.6 lakh crore. Given this, when it comes to the GDP growth during 2021-22, the next financial year, the low base effect will be at play. Even if the GDP in 2021-22 touches the GDP in 2019-20, we will see a growth of 8.4%. Nevertheless, even with that sort of growth we will be just getting back to where we were two years ago. In that sense, the covid pandemic along with the slow growth seen before that, has put India’s economy back by at least two years.

To conclude, the economy will do much better in the second half of this financial year than the first half. In fact, it already is.

The question is whether this is because of pent up demand or covid induced buying or is a genuine economic recovery already taking place. I guess, there is a little bit of everything happening.

But how strong the economic recovery is, will only become clear in the months to come, as the covid induced buying, and buying because of pent up demand, start to dry out.

Watch this space!

 

Rising Corporate Profits Aren’t Good News for Indian Economy

Salaam seth salaam seth kuch apne layak kaam seth,
Aap to khaayen murgh musallam apni to bus rice plate. 
­– Shaily Shailendra, Annu Mallik (now known as Anu Malik), Annu Mallik and Kawal Sharma, in Jeete Hain Shaan Se.

Corporates have reported bumper profits for the period July to September 2020.

This led a friend, who is generally unhappy with most of my writing given that he dabbles in the stock market which just keeps going up, to quip: “How are the corporates making profits if the economy is not doing well?

This is an interesting question and needs to be addressed. Having said that, the right question to ask is, how are the corporates making profits with the economy not doing well.

Let’s look at it pointwise.

1) A newsreport published in the Business Standard on November 17, 2020, considers the results of 2,672 listed companies, including their listed subsidiaries, for the period July to September 2020. During this period, the net profit of these companies touched a record Rs 1.52 lakh crore, up by 2.5 times in comparison to the same period in 2019.

2) There is a base effect at play here, with last year’s low base making profits this year look very high. During the period July to September 2019, telecom companies faced massive losses. Their losses have come down during the period July to September 2020. Take the case of Vodafone Idea. The company reported a loss of Rs 50,000 crore last year. The loss during July to September 2020 was much lower at Rs 6,451 crore. Similarly for Airtel, the loss came down from around Rs 23,000 crore last year to Rs 776 crore this year.

These losses pulled down overall corporate profits by close to Rs 73,000 crore, during the period July to September 2019. This time around the losses of these two telecom companies were limited Rs 7,227 crore. Hence, these two companies had a disproportionate negative impact on the overall corporate profits last year. The same hasn’t happened this year and in the process has ended up pushing up the overall corporate profit growth this year.

3) Interestingly, companies have managed to report an increase in net profit despite shrinking sales. The Business Standard report referred to earlier suggests that the net sales of these companies shrunk by 5.2% during July to September 2020. This is the fifth consecutive quarter when the sales of listed companies have shrunk. Depsite shrinking sales, profits have gone up.

4) Economist Mahesh Vyas of the Centre for Monitoring Indian Economy, looked at a sample of 1,675 listed manufacturing companies. He found that their combined net profit stood at Rs 72,600 crore, despite their net sales shirking by Rs 96,100 crore.

5) The question is how have companies managed to increase their net profit, despite doing less business than last year, leading to lower revenues. There are sectoral reasons at play. Thanks to the ongoing case in the Supreme Court, the banks did not have to report bad loans as bad loans. This has led to banks setting aside lesser money to meet the losses that may arise from these bad loans. This has clearly pushed up the profit number in the banking sector.

More specifically, the companies managed to cut more costs than they saw a fall in sales and thus pushed up their net profit.  Take the case of the manufacturing sector that Vyas has considered in his analysis, while their sales shrunk by Rs 91,600 crore, their operating expenses came down by Rs 1,33,100 crore or around Rs 1.33 lakh crore. The companies managed to drive down the cost of raw materials thanks to a favourable shift in trade terms and drawing down their inventories.

6) Other than driving down raw material cost, companies have also managed to cut down on employee costs. Economist Sajjid Chinoy of JP Morgan in a column in The Indian Express writes that net profit of companies went up despite shrinking revenues because “firms aggressively cut costs, including employee compensation.” “Indeed, a sample of about 600 listed firms reveals employee costs (as a per cent of EBITDA) was the lowest in 10 quarters,” he writes further.

A survey carried out by the Mint newspaper and Bain found that half of the companies had reduced employee costs by either firing employees or cutting their salaries.

The above points explain why corporate profits have gone up disproportionately despite shrinking revenues. Let’s try and understand pointwise why this is not good for the Indian economy.

1) A major reason for raw material costs coming down is a favourable shift in trade terms. What does this mean? No company produces everything on its own. It uses inputs which are produced by other firms. In difficult times, companies are able to drive down the cost at which they purchase things from their suppliers, that is, inputs. The suppliers are other companies, which have  to drive down their costs as well, and this is how things are pushed down the hierarchy.

How do suppliers and suppliers to suppliers drive down their costs? They also try to shift the trade terms in their favour and at the same time cut employee costs, like companies have.

2) This leads to what economists call the fallacy of composition or what is good for one may not be good for many. A simple example of this is someone going to watch a cricket match. He stands up to get a better view of the game being played and he gets a better view. But then the person behind him also needs to stand up to get a better view. And so the story continues. In the end, everyone is standing and watching the match, instead of siting comfortably and enjoying it. To repeat, what is good for one, may not be good for many.

How does this apply in the current case? When companies cut down on input costs, they are obviously paying a lower amount of money to their suppliers or not buying new raw material or as much raw material as they did in the past, to increase their inventory.

By cutting down on employee costs, they are either paying a lower amount of money to their employees or simply firing them. The suppliers in turn have to cut their costs in order to continue to be profitable or lose a lower amount of money. So, the cycle continues and in the end leads to lower incomes for everyone involved.

3) This leads to what the economist John Maynard Keynes called the paradox of thrift. With incomes coming down, people spend a lower amount of money than they did before. It is worth remembering here that ultimately one man’s spending is another man’s income, leading to a further cut in spending. Even those who haven’t seen a drop in their income or been fired, cut down on their spending. They are trying to save more, given the risk of them getting fired and not being able to find another job. This is the psychology of a recession and it is totally in place right now.

4) One of the ways of measuring the size of any economy or its gross domestic product (GDP), is to add the incomes of its different constituents. This means adding up rents, wages, interest and profits. While, profits of companies have been going up, individual wages have been going down, leading to lower spending and hence, lower private consumption. This explains why despite corporate profits of listed companies increasing at a fast pace, the GDP during the period July to September 2020, contracted by 7.54%.

5) An August 2019 report in the Business Standard said that the combined net profit of companies that make up for the BSE 500 index was at 2.31% of the GDP. Other studies suggest that this figure has constantly been coming down over the years. Despite the fact that listed companies form a small part of the Indian economy, their influence on the initial GDP figure is very high.

A large part of the Indian economy is informal. The measures representing this part of the economy cannot be generated quickly. In this scenario, the statisticians assume the informal economy to be a certain size of the formal one. Corporate profits are an important input into measuring the size of the formal economy. This is something that needs to be kept in mind while looking at the economic contraction of 7.54%. .

To conclude, while corporate profits going up is good news for the companies, there are many ifs and buts, that need to be taken into account as well, and on the whole the way these profits are being generated, it’s not good news for the Indian economy.

Also, over a longer period, the only way to grow profits is by growing sales. This will start hitting the Indian corporates sooner rather than later.

What a Mumbai Real Estate Agent Can Tell You About Indian Economy Contracting

Koi yahan aaha naache naache,
Koi wahan aahe naache naache.

— Usha Uthup, Faruk Kaiser, Bappi Lahiri and Babbar Subhash (better known as B Subhash), in the Disco Dancer

The gross domestic product (GDP) figures for the period July to September 2020 were published yesterday. The GDP is a measure of the economic size of a country during a particular period. The Indian GDP or the economic size of the country during the period contracted by 7.54%  against the same period last year.

This looks very good in comparison to the contraction of 23.92% that the economy had seen during the period April to June 2020 and has led to the uncorking of the bubbly among a certain set of politicians, economists, analysts, journalists, stock market wallahs and Twitter warriors.

Of course, there is no denying that a contraction of 7.54% is a lot better than a contraction of 23.92%, one would be a fool to deny that. But has the time to uncork the bubbly come? Or, if you are not the drinking type, should we be high-fiving on this one?

Let’s take a look at this pointwise.

1) For much of the period between April to June, the economy was under a lockdown. Once the economy was opened up, things were bound to improve. Hence, a better performance in July to September should not come as a surprise. Second, the period benefitted because of a lot of pent up demand. People who could not buy the stuff they wanted to during April to June, ended up buying it between July to September. These points need to be kept in mind.

2) The economists were expecting a contraction of 8.5-9% during the quarter. Against that a contraction of 7.54% looks just about a little better. Having said that, India has a large unorganised sector. Measuring the value added by the unorganised sector is never easy. Hence, when releasing GDP data for a period of three months for the first time, the National Statistical Office (NSO) essentially proxies the value added by the informal sector using formal sector data. This is set right as data streams in over a period of time.

Over and above this, we are in midst of a pandemic and hence, collection of data isn’t easy. As the NSO points in its release: “Some other data sources such as GST, interactions with professional bodies etc. were also referred to for corroborative evidence and these were clearly limited.”

What this means is that the GDP data presents a picture which is rosier than the actual picture.

3) There is another important point that needs to be made here. India has been publishing quarterly GDP for close to 24 years now. This is only the second time in all these years that the GDP during a particular period of three months has contracted. Only twice in 94 quarters has the economy contracted. And given that GDP has contracted in two consecutive quarters, India is in a midst of what economists call a technical recession. If the economy continues to contract in the months to come, it will enter a recession. That’s the difference between a recession and a technical recession.

Source: Centre for Monitoring Indian Economy.

4) In the period April to June with a contraction of 23.92%, India was the worst performing economy among the major economies in the world. From the data that is currently available on the OECD website, India is no longer the worst performing economy in the world, nonetheless, it continues to be among the worst performing economies in the world.

Source:  https://stats.oecd.org/index.aspx?queryid=350

5) A major surprise in the GDP data has been the recovery of the manufacturing sector. The sector grew by 0.62%, after contracting (or degrowing as analysts like to say) by 39.30% between April to June. While this is good news, it goes against the fact that index of industrial production contracted by 6.09% during July to September. If the production has contracted how has the growth come about? The growth has come primarily from the fact that companies in the listed space have been able to increase their profit margins primarily because of controlling costs, this includes firing employees and slashing their salaries.
As economist Mahesh Vyas recently wrote in a column: “In the September 2020 quarter, while sales fell again by 9.7 per cent, profits sprang a surprise by scaling up by a handsome 17.8 per cent. Yet, wages declined by one per cent. Evidently, companies do not apportion resources to labour in any proportion of profits.”

6) Sectors like construction, mining as well as services continued to remain weak, though better than they were during April to June. These sectors are high employment sectors. This remains a worry given that what seems to be happening currently is a recovery which isn’t creating enough jobs. In fact, financial services, real estate and professional services (bundled together for some reason in the GDP data) contracted by 8.09% during July to September. It had contracted by 5.33% during April to June. And that can’t possibly be a good thing. This can also be seen under NREGA data where demand for jobs this year remains astonishingly higher than last year. It can also be seen in the labour participation rate contracting with people stopping to look for jobs because they are unable to find one, and hence, dropping out of the workforce.

It also needs to be said here if there is a second round of covid, as is being feared, the services sector will continue to remain weak, in particular services like restaurants, hotels, tourism, cinema halls, malls etc.

7) If we look at GDP from the expenditure side, the private consumption expenditure contracted by 11.32% against a contraction of 26.68% between April to June. Clearly, there has been improvement on this front. Nevertheless, private consumption expenditure forms more than half of the Indian economy, and as long as it continues to remain weak, the economy will continue to remain weak. Also, we need to remember that the contraction of 11.32% happened despite pent up demand and festivals in the Western and Southern part of the country. Further, the fact that private consumption has continued to contract, brings into question the growth in the manufacturing sector. Are actual sales happening at the consumer level or is this simply a case of a  build-up of inventory, as has been the case in the auto industry?

8) This is a slightly technical point but still needs to be made. On the expenditure side, the GDP is calculated as a sum of private consumption expenditure, investment, government expenditure and net exports. Net exports is exports minus imports. In the Indian case, this is a negative entry into the GDP figure, given that exports are usually less than imports. During July to September, net exports is a positive number, given that imports are lower than exports, having fallen by a much higher rate. This is primarily because of a collapse in consumer demand, which is not a good thing. When it comes to the goods part of imports, the non-oil non-gold non-silver part of imports collapsed by 23.82% during July to September. This helped push up the GDP number.

9) The GDP has contracted by 15.67% during the first six months of the year. If the economy contracts by 3-5% during the second half of the year, we still are looking at 9-10% contraction this year. This was largely the consensus forecast made for this year. Even if there is no contraction in the second half of the year, the economy will still contract 7.66%, which will make India one of the worst performing economies in 2020-21. Also, we need to remember that the GDP of 2019-20 is likely to be crossed now only in late 2021-22 or 2022-23. So this pushes the Indian economy back by at least two years. Of course a lot of it is because of covid, but let’s not forget, the Indian economy had been slowing down even before the pandemic struck.

10) Let me close this piece with a little story. Sometime in April 2006, I first started to look for a flat to rent, in Mumbai. Of course, one had to go through agents. Pretty soon, I realised that the agents were trying a psychological trick on me. They first showed me a flat which was in a very bad state. They would then show me something which was slightly better. Nevertheless, the difference in rent between the flat was much more than the difference in their quality, with the rent of the second flat being much more than the first one. I caught on to this because I had read this book called Freakonomics sometime in 2005. The book had an extended chapter on the contrast effect.

We all tend to compare things before making a decision. Given this, the attraction of an option can be increased significantly by comparing it to a similar, but worse alternative. This is known as the ‘contrast effect’.

How does this apply in the present context? It’s simple. The fact that the Indian economy contracted by a massive 23.92% during April to June, it makes a contraction of 7.54% during July to September, much better. But there are many nuances, as explained above, that need to be taken into account.

PS: My writing has been highly irregular over the last few weeks. I was busy with a project I had taken on. Now that I am done with it, will write more regularly.