Road to recovery

Hopeful signs in data, but medium-term outlook uncertain

The third quarter of the current financial year saw the end of the Covid-induced contraction for the Indian economy. According to the latest official data, gross domestic product (GDP) during October-December 2020 expanded by 0.4 per cent, year-on-year, at constant prices. Gross value added (GVA), which is a better gauge of economic activity, expanded by 1 per cent during the same period, compared to a decline of 22.4 per cent and 7.3 per cent in the first and the second quarter, respectively. Recovery in the third quarter was aided by an expansion in the agriculture sector at 3.9 per cent, while the manufacturing sector registered growth of 1.6 per cent. The construction sector expanded by 6.2 per cent. Although private consumption remained in contraction mode, investment expanded moderately after a sharp decline in the first half of the year. Lower demand for high-contact services continued to affect overall consumption.

For 2020-21, according to the second advance estimates of national income, the Indian economy is expected to contract by 8 per cent, compared to the earlier estimate of 7.7 per cent, partly because of a significant increase in subsidies. Allocation for subsidies went up from Rs 2.27 trillion in the Budget Estimates for the current fiscal year to Rs 5.95 trillion in the Revised Estimates. The back-ended payment of subsidies is expected to pull back GDP growth into negative territory in the fourth quarter. GVA for the full year is expected to contract by 6.5 per cent. Notably, the first advance estimates had projected a contraction of 7.2 per cent.

At a broader level, while economic activity continues to recover, there are several factors worth noting. For instance, since this is truly an unprecedented year, the numbers could be revised significantly. Thus, the precise state of the economy may not be known for a while. Further, recovery is not evenly spread. Although the manufacturing and construction sectors have done relatively well, some segments in services are lagging. Full recovery in these segments would depend on the pace of the vaccination programme. A rapid increase in new infections will not only be a risk for high-contact services but also for the pace of overall economic recovery. Additionally, recovery has been fairly sharp in the corporate sector, which was visible in the third-quarter company results. But the unorganised sector and small businesses are likely to have suffered disproportionately, which will directly affect employment and sustainability of recovery.

It is important to recognise that the headline numbers would show a jump in the next fiscal year, starting April 1, but they should not be seen as a trend. To be sure, medium-term growth challenges have only increased over the last few quarters. Government finances, for example, both at the Central and state levels are stretched. As a result, overall Central government spending is projected to increase only marginally in the next fiscal year. The bond market has also started expressing dissatisfaction over the sustained large government borrowing. Pressure on government finances could adversely affect growth-enhancing capital expenditure. A significant increase in interest rates can hurt profits and investment in the private sector. Support from the monetary policy will also remain limited. Thus, while the latest data has a number of encouraging signs, the medium-term outlook remains uncertain.