Q2 GDP suggests glass is probably ‘half full’; need to look negative growth numbers in rear-view mirror

November 30, 2020 12:14 PM

There is likely to be a pain in the short-term, but the outlook in the medium-term may improve significantly with a reduced number of infections.

After a record slide of 23.9% in the June quarter, the year-on-year contraction in real GDP narrowed to 7.5% in the second quarter of this fiscal.

Rumki Majumdar

The GDP of the economy contracted by 7.5 percent, which is encouraging because now we know the recovery in Q2 has turned out to be stronger than what was anticipated by a majority of the market analysts. The silver lining was the marginal but positive bounce in the manufacturing sector, after a contraction of 39.3 percent in Q1. The ‘financial, real estate, and professional services’ sector contracted by -8.1 percent, which was higher than the contraction seen in Q1. This suggests a lagged impact of the pandemic on the financial sector even as remote working due to intermittent lockdowns continued to impact professional services. The domestic private demand contracted significantly during this quarter. In all, the economy contracted by 15.7 percent in the first half of FY2021 relative to FY2020. 

The contraction in the first two quarters of this fiscal year is no surprise. India was among the very few countries to have gone into a nation-wide lockdown post the pandemic and the economic unlock happened gradually in phases during these two quarters. With the contraction so large in the first half of the fiscal year, expecting negative growth this entire fiscal year relative to the previous year is discernible. The key question is where the economy is on the path to recovery. Since the quarterly GDP data is released with a lag of two months, we should look at these negative growth numbers in the rear-view mirror, keeping in perspective that recent high-frequency data suggest a healthy rebound.

A 10-year high PMI manufacturing index, stronger car sales, rising production of finished steel and diesel consumption, and higher goods and services tax revenue collections indicate that the economy has bounced back strongly since the ‘unlock’, backed by pent-up and festive season demand. 

Nevertheless, sustaining this rebound could be a challenge next year. The google mobility index suggests people are avoiding parks, recreational areas, and transit stations as they are worried about falling sick. The purchasing power of consumers has been impacted well. The labour market has been weak as unemployment is rising and according to CMIE, the number of people who feel wealthier this year compared to the last year has declined sharply. The negative wealth effect could be impacting the ability to spend more. Besides, inflation has remained persistently high. 

Falling infection and increased mobility will be key, going forward, and we may have good news from that perspective. The overall number of infections in India is coming down, except for a few regional spikes, and the fatality rate is much lower. The possibility of the release of several highly effective vaccines soon gives us hope that there is an end date to the pandemic, even if it may not be immediate. 

With improved mobility, pent up demand for more elastic discretionary goods will pick up faster, especially among the top 10 income percentile of the population, who could not spend during this period. Mobility restrictions may ease inflation in food prices, although if demand rises faster than supply, core prices may escalate. Prolonged low investments, which have been contracting for five consecutive quarters now, will impact existing production capacity and investment will have to increase faster to catch up with the rising demand. Lastly, stimulus measures announced by the government and liquidity measures by the RBI will likely help prop up industrial activity and demand. 

In short, there is likely to be a pain in the short term but the outlook in the medium term may improve significantly with a reduced number of infections. India’s GDP may rebound in double digits in FY2022 after contracting in FY2021. 

Rumki Majumdar is an Economist at Deloitte India. Views expressed are the author’s personal. 

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