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What's Behind India's Worst GDP Contraction in Decades?

Sep 3, 2020 6:21 AM 3 min read

As everybody would have heard by now, India’s GDP contracted sharply, as was largely expected, for the first time in decades due to the COVID-19 pandemic and resulting lockdowns.

The GDP number for the April-June quarter (Q1FY21) was released yesterday. It showed a 23.9% YoY contraction - the first in 40 years - and the worst growth number since 1996, which was when India began compiling quarterly data.

That wasn’t the only damning economic development yesterday. Looking into the numbers and beyond the flashy headlines, there were other damning pain points. Official data showed the industrial sector deep in the red, plummeting 38.1%. The combined index of eight core industries contracted 9.6% in July (again YoY). Manufacturing and services reported steep falls of their own: by 39.3% and 20.6% respectively.

Silver Lining: If it’s any consolation, there is some good news as well. The agricultural sector proved to be a lonesome bright spot, reporting 3.4% growth. Moreover, data regarding manufacturing sector activity in August (released today) showed growth for the first time in five months.

But all in all, the state of affairs right now remains grim. The silver lining is too thin. The fact of the matter is that the economy is in serious dire straits . After all, while it was widely expected that Q1FY21 numbers would show contraction, the consensus was that it would not exceed 20%.

So what does the -23.9% number imply?

One: The annual growth rate for FY21 will now take a hit. A conservative estimate is that the growth number for the entire fiscal year could be -7%.

Two: The extent of contraction also reveals the sheer gravity of the situation. India instituted the world’s strictest lockdown to combat COVID-19. The entire economy was shuttered for nearly two months, and since then too lockdowns have continued in some places or for some sectors. Despite these measures, the country has still become a virus epicentre, with daily confirmed cases now averaging c. 70,000 and the death toll climbing. This means that the pandemic’s peak is far from sight...which is to say the economy’s tribulations might not end anytime soon.

Three: Near-24% contraction also reflects how sweeping the damage has been. All key indicators showed massive YoY falls. Everything from production of coal and commercial vehicle sales to railway passenger count and even the number of telephone subscribers has taken a drastic hit.

Four: The severity of the situation could mean more interventions by the RBI and the Government in the near-term. Although, considering the widening fiscal deficit and depleting state coffers, the scope for a potential Atma Nirbhar Package 2.0 is limited.


The Slide Before the Crash

To be fair, India is not an outlier in the global economy right now. Nearly all major economies reported contractions in the April-June quarter (ironically, China, which is where the pandemic began, was an exception).

But India has still fared worse than most of its peers. This may have to do with the fact that India’s economic troubles predate the pandemic. The crash was preceded by a slide. GDP growth had been slumping for many quarters now. Before the lockdown, many sectors were battling a prolonged slowdown that had dragged growth down to 3.1% in Q4FY20.

This meant the Government, RBI, industries and businesses were ill-equipped when the pandemic came knocking. The coronavirus aggravated an already-bleak situation.

The Road Ahead: To escape the quagmire of recession, India will need to act quickly and decisively.

Heightened Government spending supported by strong reforms is the desperate need of the desperate hour.

These include fixing the shortfalls of MSMEs, revamping public-sector assets, active disinvestment of loss-making state-owned entities, power-sector reforms, banking reforms, rationalising the tax regime to ensure higher tax collections and simpler taxes, increasing spending on public infrastructure (especially healthcare, considering the current situation), and more.

And these reforms need to be definitive and sweeping. The impact on the economy has been structural; the reforms will have to be structural too.

Meanwhile the RBI will perhaps continue to focus on stimulating growth. And a key external factor that bodes well for a domestic recovery is the US Federal Reserve’s strategy shift last week where it said it would end decades of active inflation-targeting and let interest rates remain at near-zero levels for possibly years to come. What this is likely to lead to is a weaker Dollar and more capital inflows into emerging markets. This might take some heat off Central Banks in countries like India. The RBI can now keep the repo rate and borrowing costs low (provided the inflation rate doesn’t run amok).


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