GDP contraction

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!

 

CONFLATION (Contraction + Inflation) is Here. And It Will Stay This Year.

The British politician Ian Macleod is said to have first used the word stagflation in a 1965 speech he gave to the Parliament, where he said:

“We now have the worst of both worlds—not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of “stagflation” situation. And history, in modern terms, is indeed being made.”

The words stagnation and inflation came together to create the new word stagflation. The economic growth in United Kingdom in 1965 was 2.1%, falling to 1.6% in 1966. Consumer prices inflation during the year was at 4.8%. While, this might not sound much, it was the highest in more than half a decade. Inflation in United Kingdom would touch a high of 24.2% a decade later in 1975.

Hence, stagflation became a term which referred to a situation of slow economic growth or stagnation and high inflation.

Many economists and analysts are asking if India has entered a stagflationary scenario now, just like the British had in the mid 1960s. The consumer prices inflation for August 2020 was at 6.7%. The consumer prices inflation for April to August in the current financial year has been at 6.6%, higher than the Reserve Bank of India’s comfort range of 2-6%.

What is worrying is the food inflation level. Food inflation in August was 9.1%, whereas food inflation during this financial year has been at 9.6%. Within this, the inflation in the price of vegetables was at 10.9%, oil and fats at 11.8%, pulses at 18.2% and that of egg, fish and meat at 15%.

At the same time, the Indian economy as measured by its gross domestic product (GDP) contracted by 23.9% during April to June 2020, in comparison to a year earlier. Things are expected to slightly improve during the period July to September 2020, but the Indian economy will contract in comparison to last year.

Hence, during the first six months of 2020-21, India will see the economy contracting and high inflation. Stagflation doesn’t quite represent this scenario, for the simple reason that stagnation represents slow economic growth and not an economic contraction as big as the one India is seeing.

As Macleod put it in the 1960s: “History, in modern terms, is indeed being made.” What was true in the 1960s Britain is also true about the 2020 India.

Given this, it’s time to coin a new word to represent this particular situation of economic contraction plus inflation and call it CONFLATION (I considered Contraflation as well but somehow Conflation just sounded better and the word anyway means the merging of ideas, so, works that way as well).

What does this conflation really mean in the overall scheme of things for India for the remaining part of the year? Let’s take a look at it pointwise.

1) A high inflation, especially food inflation, during a time when incomes are contracting is going to hurt the economy badly. People are having to pay more for food while their incomes are contracting. This means that spending on non-food items is going to come down. This will impact overall consumer demand right through the remaining part of the year. It is estimated that poor households allocate up to 50% of their expenditure towards food. So, conflation will hurt.

Lower consumer demand also leads to a fall in investments simply because there is no point in corporates expanding production, when people aren’t buying things like they used to. This again will negatively impact the economy. (A contraction in investments has been negatively impacting the economy for close to a decade now).

2) High food inflation has primarily been on account of supply-chains from rural to urban India, breaking down. This means that the farmers are not the ones benefitting from the high food prices. Basically, the traders, as usual, are cashing in on the shortage.

This can be gauged from the fact that food inflation as measured by the consumer price index during the year has stood at 9.6%.

Food inflation as measured by the wholesale price index has stood at 3.1%. This clearly tells us who is benefitting from food inflation. It’s clearly not the farmers. If farmers need to benefit, the terms of trade need to shift in their favour, something that hasn’t happened in many years.

3) Some economists have been of the view that food prices will slowdown in the second half of the year, thanks to a bumper agricultural output. Anagha Deodhar of ICICI Securities writes: “We expect vegetable and pulses inflation to start moderating from September 2020 and October 2020 respectively due to base effect. These two items together account for almost one-fifth of food basket and hence meaningful decline in their inflation rates could keep a lid on headline inflation as well.”

While this is true, what this view does not take into account is the fact that covid is now spreading to rural areas. As Crisil Research put it in a recent report: “Of all the districts with 1,000+ cases, almost half were rural as on August 31, up from 20% in June.” This basically means that the supply chain issues when it comes to movement of food are likely to stay, during the second half of the year as well.

Also, the spread of the pandemic could impact the harvesting and the marketing of agricultural products. Hence, overall agricultural production may not grow along expected lines. Given this, food inflation may not fall as much as it is expected to and might continue to remain elevated. Again, a sign of conflation hurting the economy.

4) The medical facilities in rural India are nowhere as good as the ones in urban India (This is not to say that medical facilities in urban India are excellent). The spread of covid pandemic will mean that people will have to spend money treating the disease.

This will lead to the cutting down on spending towards other items. Also, more importantly, the spread of the pandemic will even have an impact on the spending of people who haven’t been affected by it. People will save more for the rainy day. So, conflation will continue to hurt the Indian economy.

5) Another factor that needs to be taken into account is the fact that the money supply* has gone up by more than 11.7% consecutively for the last four months. This hasn’t happened since 2014. What this tells us is that the Reserve Bank of India is really pumping in money into the financial system. If all this money keeps floating around in the months to come, then there is a real danger of this leading to a further rise in prices. (A piece on how the RBI has botched up the monetary policy remains due).

6) But all this remains valid only for 2020-21. Come 2021-22, and India will be back in growth territory again and hence, conflation will be out of the picture. This, as I had explained in an earlier piece, will primarily be because of the base effect.

Basically, the GDP figure in 2020-21 will turn out to be so terrible that it will make the GDP growth in 2021-22, look fantastic. But this won’t mean much because only in 2022-23 are we likely to go past the GDP figure of 2019-20. This means the Indian economy is likely to go back by two years and that will be the cost of conflation.

To conclude, the Indian economy will contract during the second half of the financial year. There is a slim chance of growth being flat for the period January to March 2021. Inflation, even though it might come down a little, is likely to remain high due to the spread of the covid pandemic. Hence, India will see conflation through 2020-21.

* Money supply as measured by M3.

The US Economy Contracted by 9.1% and not 32%. India’s Economy Contracted by 23.9%.

Summary: I had absolutely no plans of writing this. But given what has been happening on Twitter and WhatsApp since the morning, I was forced to write this. Please read and share widely.

There is a full-fledged controversy raging on the internet where people have said that the economy of the United States, as represented by its gross domestic product (GDP), contracted by 32%, during April to June 2020. This was worse than India’s contraction of 23.9%.

This comparison is totally wrong. The way the United States reports GDP growth/contraction is different from the way India does. Let’s try and understand this in detail.

In April to June 2020, the US economy contracted by 9.1% in comparison to January to March 2020. This is a quarter on quarter comparison. This figure is then annualised.

How do we annualise it?  We do that by assuming that the US economy will continue to contract by 9.1% quarter on quarter, over the next three quarters (basically we compound in a negative direction, since the economy is contracting). Let’s understand this through a simple example.

So, let’s say during the January to March 2020, the size of the US economy or its GDP was $100. In April to June 2020, this contracted by 9.1%. The size of the economy came in at $90.9 ($100 – 9.1% of $100).

In July to September 2020, the economy will contract further by 9.1% to $82.63 ($90.9 – 9.1% of $90.9).

In October to December 2020, the economy will contract further by 9.1% to $75.11 ($82.63 – 9.1% of $82.63).

In January to March 2021, the economy will contract further by 9.1% to $68.27 ($75.11 – 9.1% of $75.11).

Hence, by the end of one year, the economy has contracted from $100 to $68.27 or by 31.73%, which is nearly equal to 32%.

This is how the GDP growth/contraction numbers in the US get reported. Hence, by this logic, on an annualised basis, the US economy contracted by close to 32% in the period April to June 2020, in comparison to January to March 2020. But this figure can’t be compared with the Indian figure.

The Indian system is different. The GDP during a particular quarter is compared to the GDP during the same quarter in the last year. In the Indian case, the GDP contracted by 23.9% during April to June 2020, in comparison to April to June 2019 (and not January to March 2020, as is the case with the US). The Indian comparison is a year on year one and not a comparison with the previous quarter. The US comparison is a quarter on quarter comparison which is then annualised.

If the US were to report the GDP growth/contraction in the same way as India, its GDP during April to June 2020 contracted by 9.1% in comparison to the GDP between April to June 2019. The Indian economy contracted by 23.9% during the same period. That’s the right comparison.

This is the right way of looking at things and not how they are being misrepresented on the social media, even by experienced economists.