Large enough swathes of the economy remain in trouble, so increased government expenditure will remain critical
It is a relief that the economy isn’t doing as badly as one had feared. But, behind the headline numbers, there are some worrying trends; the recovery isn’t as broad-based as it should be and the all-important services sector is still struggling, having contracted a steep 11.1% in the three months to September. And, while growth may turn positive in the fourth quarter—on the back of the pitiable 3.1% recorded in Q4FY20—or even in Q3, that can hardly be reason to cheer. The fact is we have lost a big chunk of the value-addition, and getting back to a growth trajectory of a sustainable 7%, even on this diminished base, now looks difficult.
If the GDP and GVA growth numbers for Q2FY21 have surprised on the upside, contracting 7.5% year-on-year (y-o-y) and 7% y-o-y, respectively, it has much to do with the manufacturing GVA that, at an increase of 0.6% y-o-y, has outperformed estimates. This was reflected in the corporate results, where we saw revenues fall but operating profits jump; for a sample of 2,334 companies (ex- financials) revenues were down 8% y-o-y in Q2FY21, but operating profits soared by nearly 50% y-o-y, boosted by deep cuts in expenditure (of as much as15% y-o-y led by a fall in raw material costs, which came off by 400 bps y-o-y).
It would appear the performance of the large informal sector, comprising thousands of enterprises, may not have been captured in the GDP data, or has been captured only partly. However, it is the informal sector, several times larger than the formal sector and employs millions, that has been more badly hit. Economists have pointed out that much like it happened post-demonetisation, this time too the informal sector would have lost out. While it will make a comeback, how soon that will happen is not clear.
The sharp fall in factory output in Q2, of 6.7% y-o-y, is more in sync with what the high frequency indicators are telling us. Indeed, even in October, the IIP contracted 2.5% y-o-y on the very weak base of negative 5.5%. It is these contractions—for instance, in the output of steel or refinery products—that put a question mark on the pace and sustainability of the recovery. In fact, retail sales of cars and two-wheelers also contracted in October, and while the festive and wedding season would no doubt boost demand for consumer goods, if the demand is to bounce back meaningfully and sustain thereafter, it cannot happen without big-ticket investments.
However, gross fixed capital formation has now contracted five quarters in a row, well before the pandemic set in. The sharper-than-expected rebound in fixed investment growth, to -7.3% y-o-y in Q2, led by private sector initiatives is little consolation because it is not enough to put consumption demand at levels where it grows by 7-8% sustainably. While the private sector will continue to invest, it is the government that needs to do the heavy lifting.
Apart from one or two conglomerates that can put capital to work, much of the private sector remains leveraged. However, the government appears to be overly worried about the subdued tax collections leading to a wider fiscal deficit and the debt-to-GDP ratio spiralling out of control. The stimulus notwithstanding, government final consumption crashed 22.2% y-o-y, public administration was down 12.2% and investments, too, were smaller.
Revenue expenditure between April and October has increased by an anaemic 0.7% y-o-y compared with an average of 13%-plus in previous two years; capital expenditure has fallen 2%. As economists have pointed out, it is important to spend now to boost consumption as also tax collections; if the purse strings aren’t loosened, the economy could stay in the rut, leaving the deficit wider for a longer period. The combined impact of the stimulus packages is around 1.8% of GDP and hopelessly inadequate.
This should be evident from the weak pullback in private final consumption expenditure—which contracted 11.3% y-o-y—compared with a negative 26.7% y-o-y in Q1. That consumption would be weak between April and September was a given, and that it would pick up in October and November—during the festive season—was also not in doubt.
Nonetheless, one expected a slightly better rebound. For the economy to get back on to the growth track, consumption must remain strong even beyond December, but, right now, this looks unlikely because apart from some industries—IT, e-commerce—the entire services sector remains moribund. As most economists have pointed out, there is a fairly strong element of pent-up demand that is built into the consumption spends for Q2, which could be seen possibly even in Q3. However, much of this would have faded by end-Q3. The relatively muted spends during the festive season suggest not all consumers are sure of their jobs or incomes; the surge in deposits at banks suggests more consumers are now saving.
While the agri and rural sectors are holding up, the MSME sector has borne the brunt of the disruption; since the banks are reluctant to lend beyond a point, the government must step in with a big spending push. Else, it is hard to see the growth engines roaring back to life.