GDP contraction: Big government expenditure is a must now to revive the country’s ailing economy

The severe contraction of the Indian economy in the first quarter of 2020-21 at 23.9 per cent, though on expected lines in the face of a total lockdown in April-May, is certainly a wake-up call for the government to carry forward major structural economic reforms to quickly revive and get back to a high growth path.

Analysts have already forecast that growth in the rural and agricultural economy will not be sufficient to compensate for the decline in urban demand and estimated the FY21 GDP contraction could be anything between 5 and 12 per cent if all goes well in the remaining period of the year and that there is no fresh outburst of Coronavirus needing a severe lockdown again.

Former finance minister P Chidambaram has said that of the world’s major and advanced economies, India’s economy declined more than any other country’s except the economy of the United States. “What does that tell us? That Mr Modi stands second only to Mr Trump in terms of incompetent economic mismanagement.”

The quantum of negative growth shows the impact of lockdown has been way higher than anticipated, rating agencies say, but the industry feels that the deep contraction in GDP is on expected line and that the recovery will be gradual.

The industry says the steep 23.9 per cent contraction in the GDP in April-June reflected the "stalling of economic activities" due to the lockdown imposed in response to the pandemic. However, it anticipates that the economy will stage a gradual recovery in the coming quarters on account of reforms, the Rs 20 lakh crore stimulus package announced by the government and measures taken by the Reserve Bank of India.

The economy badly tanked in April, when there was a complete lockdown. Even the agriculture sector, which works out in the open and could have continued normally, was adversely impacted due to collapse in demand and freezing of trade and transportation. Arrivals in North Indian mandis were half of what they were in April 2019. Floriculture, horticulture, vegetables, poultry and milk are some of the commodities which suffered. Though the Rabi crop posted a record harvest, agriculture production as a whole would have risen little in April-May.

Production of essentials was permitted during the lockdown, but fast-moving consumer goods (FMCG) firms faced a decline. Most people could not go to work, so roads were empty and offices and factories were shut. Government offices were also closed and only the essential administration and police were functional. In fact the economy would have been working at less than 25 per cent of its level in April 2019. Still the economy is not working at more than 60 per cent. If the miserable plight of unorganized is not fully captured and had it been the case, contraction could have been steeper.

But what is more worrying is that apart from the sharp decline in quarterly growth due to the lockdown is that Indian economic growth has been steadily declining since 2016. According to former Chief economic advisor and World Bank chief economist Kaushik Basu, these are warning bells that all is not well with the economy and if quick remedial measures are not taken, India will miss the bus to get back to a high growth path and the economic development will be pushed back by years.

The reason for the slowing economic growth since 2016 is demonetization, and unfortunately the unorganised sector decline is not captured in the GDP data. It is not captured in annual and quarterly GDP data. Agriculture is the only component of the unorganised sector whose data is used. The unorganised sector is 94 per cent of employment and 45 per cent of output of the economy.

India has become the worst performing economy among the G20 nations in the April to June quarter. Britain is the next worst at -20.4 per cent and China is the best performing with a positive rate of growth of 3.2 per cent. Within one quarter, China turned around from -6.8 per cent to a positive rate of growth.

Analysts say the reason for this is that lockdown was not properly implemented. Also there is a very large unorganised sector unlike other big economies. People in this sector are poor and cannot cope with a crisis. The authorities have ignored this factor.

As a way forward, India’s former chief statistician and economist Pronab Sen feels that the government needed to step up its own expenditure. Expecting people to draw down their savings indefinitely won’t be enough as much of the poor and middle class may have already wiped out their savings. The government can borrow from the market or the RBI. “I don’t understand their reluctance to do so. Is the government willing to let the economy go down the tube because they want to shore up their fiscal deficit numbers?” he asked. He expects a 10 per cent-12 per cent contraction in annual GDP, although he feels that the last quarter of the year may show some modest growth.

The Ministry of Commerce and Industry also released data recently on the eight core infrastructure sectors showing that output contracted for a fifth straight month in July, with the 9.6 per cent decline driven by a fall in production in the steel, cement and refinery products industries. The Chief Economic Advisor, Krishnamurthy Subramanian pointed to the core sector data as one indicator of a “V-shaped recovery”, as it has eased since the 38 per cent contraction in April.

“If you look at railway freight traffic, which is often times a good indicator of economic activity, in July, it is 95 per cent of the level that it was last year. In fact, in the first 26 days of August, it is 6 per cent higher than the same period last year. Power consumption is only 1.9 per cent lower than last year. E-way bills in August, which capture inter-state trade, are at 99.8 per cent, almost the same as last year, despite the presence of some local lockdowns. So overall, there is a V-shaped recovery. We should expect a better performance in the subsequent quarters,” he says, adding that the GDP contraction should be put in the context of a global recession due to COVID-19.

Former RBI Governor Raghuram Rajan, however, had a different take. He is right in saying government needed to come out with big stimulus package particularly to push demand as GDP numbers clearly ring alarm bells. Government’s plan to conserve resources for a future stimulus is self defeating. India needs relief now.

Rajan too is of the view that 23.9 per cent contraction of GDP in the first quarter of 2020-21 will probably be worse when estimate of the damage to the informal sector is available. This contraction is in sharp contrast to the drop of 12.4 per cent in Italy and 9.5 per cent in the US, two of the most COVID-19 affected advanced economies.

Besides, the pandemic is still raging in India so discretionary spending, especially on high contact services like restaurants and the associated employment, will stay low until the virus is contained.

India needs strong growth and the recent pick up in sectors like autos is now evidence of the much awaited V-shaped recovery, Rajan says in an article, adding that to improve competitiveness, long debated reforms to land acquisition, labour, power and the financial sector should be implemented, as should the recently announced reforms in agriculture.