Hit hard by lockdown, economy on firm path of fragile recovery

One could interpret data in different ways. One may say that gross domestic product (GDP) contracted an unprecedented 23.9 per cent in the first quarter and 7.5 per cent in the second quarter, plunging the economy into a recession for the first time in its independent history as Covid-induced lockdowns hit hard.

On the other hand, one could also argue the economy did not decline in double digits in the second quarter as was expected after the first-quarter numbers were released, giving a glimmer of hope that a recovery is in the process.

The first Advance Estimates predicted the economic contraction at 7.7 per cent for FY21, down from 15.7 per cent witnessed in the first half. This means the economy would grow by a marginal 1.91 per cent in the second half.

Though the first case of Covid was detected at the end of January last year, the impact on the economy began to be felt towards the end of March, when the first nationwide lockdown was announced. The slowing down of the economy in the January-march period (see chart) was primarily due to factors other than Covid.

After the lockdown was lifted in September, various parameters of the economy did show some recovery.

Is the recovery fizzling out as the November data points out?

Most data, be it the index of industrial production (IIP) or exports, suggest that the recovery unleashed by unlocking in September proved temporary and was mainly due to pent-up demand.

The IIP, contracting since March, recovered marginally by growing 0.5 per cent in September. It further rose to 4.19 per cent in October, giving signals of recovery. However, it petered out in November as the month saw the index contracting 1.9 per cent.

The same trend was shown by exports (see chart).

Devendra Pant, chief economist at India Ratings, said: “The economy is in recovery mode and recovery is fragile, as evident in the growth of the IIP. The minor industrial recovery we saw in September and October was mainly due to pent-up and festival demand.”

Fiscal deficit

By the time the first month of the current fiscal year was over, it was clear that the Centre would not be able to stick to its Budget estimate of reining in its fiscal deficit at 3.5 per cent of GDP. This was substantiated when the Centre announced its plans to increase market borrowing to ~12 trillion from the ~7.8 trillion announced in the Budget. The new amount of market borrowings constitutes 6.1 per cent of GDP, projected by the advance estimates for the current fiscal year.

By November, the fiscal deficit had crossed the Budget estimate by 35 per cent. However, at ~10.75 trillion, there is still ~1.25 trillion that can be banked upon from market borrowing to finance the gap. In fact, goods and services tax collection rose to a record figure of ~1.15 trillion in December. Also, the contraction in direct taxes compared to the previous year narrowed to 9.2 per cent by the middle of January from 13 per cent seen on December 16.

Inflation

If the RBI fails to keep the average retail inflation rate within the 2-6 per cent band for three consecutive quarters, it would be considered a lapse on its part and the central bank would have to give an explanation to the government, according to the monetary policy framework. If the imputed inflation rates for April and May are considered, the RBI has failed to keep its mandate to keep the retail price inflation rate within the band in September itself. However, it did not consider the figures for April and May because those were imputed numbers.inflation continued to be over 6 per cent till November before cooling to 4.59 per cent.

“Consumer price inflation recorded a volatile trend in 2020, with spikes related to supply-side disruptions during the lockdown and the unlock period as well as food prices,” said Aditi Nayar, principal economist, ICRA.

External account

Because of low demand in the economy, there was a current account surplus of 3.8 per cent of GDP in the first quarter, which is a rarity in India. Factoring in all capital accounts, there was an accretion of $19.8 billion in the first quarter of the current fiscal year against $14 billion in the same period of 2019-20.

The current account surplus moderated to $15.5 billion or 2.4 per cent of GDP in the July-september quarter due to a rise in the merchandise trade deficit to $14.8 billion from $10.8 billion in the preceding quarter. There was an accretion of $31.6 billion to foreign exchange reserves as compared to $5.1 billion in the same quarter of 2019-20.

SBI group Chief Economic Advisor Soumya Kanti Ghosh estimated the current account balance at a deficit of 0.6 per cent of GDP in the third quarter and 0.8 per cent in the fourth one.