Rational Expectations: FM is flying blind, won’t get fixed soon

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December 16, 2020 6:15 AM

Forget auto sales or other such data as this misses the huge informal sector; only massive govt-spend can fix things

No sustained GDP growth, of course, can take place till private capex is restored—government capex is just 25-30% of the total after all—and that requires sustained reforms.No sustained GDP growth, of course, can take place till private capex is restored—government capex is just 25-30% of the total after all—and that requires sustained reforms.

Talking up the economy, as the PM did at Ficci, is important, but it is more important for him to keep in mind the ‘recovery’ is, at best, patchy; large parts of the economy—especially the unorganised sector that few track—are in deep trouble. It is important that the government does not, to use the colourful Americanism, drink its own Kool Aid. Right now, the limited government spending suggests it believes there is a reasonable economic revival, so it can go slow on the spending.

The better than expected performance in Q2 this year, when GDP contracted 7.5% versus a 23.9% contraction in Q1 has a lot to do with the stunning results of the corporate sector; as my colleague Shobhana Subramanian (bit.ly/3ns9oMB) pointed out, for a sample of 2,334 companies (ex-financials), y-o-y revenues were down 8%, but operating profits soared by nearly 50%. Within the corporate sector, as HSBC’s chief economist for India, Pranjul Bhandari, points out for another sample, large-cap firms saw sales fall 7-8%, but net incomes rise 50% while small-caps saw profits rise just 7-8% even as their sales also fell around 7-8%; in other words, the impact was quite different.

Indeed, for the June quarter, Bhandari finds that while the larger firms saw their staff costs remain flat, the smaller ones cut them by 20%; that, in turn, has important demand implications. And there is no up-to-date data on the unorganised sector firms, which would have fared very badly with demand collapsing post-Covid. With no data likely on this sector for at least a year, the finance minister will, in a sense, be flying blind for the coming budget and possibly even the next one. In which case, she will need to navigate by just gut instinct, guided by a few macro relationships that are infallible.

Private consumption demand, we know, is the mainstay of the economy as it contributes around 55-60% of GDP; while it contracted a smaller 7.7% in Q2 (at current prices) as compared to 24.5% in Q1, keep in mind it was slowing even pre-Covid. This grew just 8.9% in FY20 versus the 15.3% it grew the year before Narendra Modi first became prime minister. Investment demand is typically 25-30% of the economy, and while this contracted seven percent in Q2, it contracted by 0.3% long before Covid in even FY20.

So, while auto sales or other such indicators show the economy is in ‘recovery’ mode—PMI is pretty much at pre-Covid levels—it is equally true that there has been a 50% jump in the number of rural households looking for low-paying MGNREGA jobs; from an average of 18-mn households per month in Apr-Nov 2019 to 28-mn in Apr-Nov 2020. Why would so many be looking for such poor-quality jobs if the economy was recovering so well? Almost all the data we are seeing right now pertains to the organised sector. Indeed, to the extent the organised sector’s share is rising—due to people buying more online—this hides the collapse of the unorganised sector.

That the economy will remain in poor shape for a while is obvious from just the basic income identity Y=C+I+G+X-M where Y is GDP, C is private consumption, I is investment, G is government consumption expenditure, X is exports and M is imports. Around a fourth of I is government investment (Centre, states and PSUs) and 35-40% each is that by the corporate (India Inc) and non-corporate (MSMEs and household investment in real estate) private sector.
We know that C is in trouble and till the uncertainty over jobs remains, its growth will be muted; it is hardly surprising, then, that for Q1FY21, RBI found household financial savings jumped to 21.4% of GDP as compared to 7.9% in Q1FY20.

Corporate investment was in trouble even before Covid and, to the extent MSMEs have been hit hard, capex by the non-corporate private sector will continue to contract. And we already know that, for all the talk of the stimulus, in the first half of FY21, central government expenditure contracted a bit while it was budgeted to rise by 12.7%. With states’ finances in terrible shape, chances are their expenditure will remain muted; states account for 55-56% of central and state expenditures put together.

While this is presumably why finance minister Nirmala Sitharaman said, at a Bloomberg conference recently, that she was not going to worry too much about the deficit, but would spend what she needed to, it is not clear just how much she will hike spending by. Ideally, central spending must try and make up for as much as possible of the slowing of state government expenditure, private consumption, etc.

Funding this through higher borrowing will not be as tough given the flood of liquidity and while the Centre is worried about the rise in deficit levels, as JP Morgan’s chief India economist Sajjid Chinoy points out, if GDP doesn’t bounce back —and it cannot if large parts of the economy remain impaired due to lack of demand—both debt and deficit will remain high and precarious (bit.ly/2LmjYX1) over the next few years. So the FM has to ensure central and state deficits are not compressed too fast over the next few years.

While it is heartening to hear the disinvestment secretary tell Ficci that the next phase of disinvestment will be ‘much more ambitious than anticipated’ as this can help fund part of the increase in Central capex, keep in mind that in the last five years, disinvestment receipts touched a maximum of just 0.6% of GDP in FY18. No sustained GDP growth, of course, can take place till private capex is restored—government capex is just 25-30% of the total after all—and that requires sustained reforms.

That is the other reason why prime minister Modi cannot afford to give in to the agitating farmers of Punjab; as happened after he failed to push the land reforms Bill in 2014, giving in now will reduce his ability to effect any meaningful change for several years.

Twitter: @thesuniljain

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