India’s GDP Contraction

How does it impact a common man?

India’s GDP Contraction
India’s GDP Contraction

The inevitable has transpired. The contraction in the gross domestic product (GDP) of India was anticipated. It was expected that there will be a big fall in the Indian economy in tune with the rest of the world economies. However, that the GDP would be shaved off nearly by a quarter in the first quarter of financial year 2020-21 is a shock. A few months ago, when the nation-wide lockdown was implemented, the mass departure of the migrant labourers had brought us the images. The estimates released by the National Statistical Office (NSO) under Ministry of Statistics and Programme Implementation on 31st August, 2020 confirms those images and provides a numerical precision of the economic woes – the GDP of India suffered its steepest contraction by 23.9% in the April-June quarter. In simple words, the pandemic crisis and the subsequent lockdowns has annihilated almost ₹ 8.45 lakh crore worth of economic activities in the first quarter of the financial year 2020-21. What is worse is that the data given by NSO could be an underestimate. Primarily there are two reason behind this. First, the data of India’s massive informal sector collected was only over a period of time. The reason why the sector is called informal is that the data about this sector can never be collected at one point of time, more and more data keep coming with time. Secondly, the data of smaller unlisted businesses also is not collected at a given point of time but over a period. Both, the small business as well as the informal sector have been worst hit by the coronavirus pandemic. Once the data of these sectors are accounted for, there are high possibilities that the revised GDP figure will be worse. In other words, when the data of these two sectors will be calculated correctly, the revised figure will vouchsafe more contraction. This is why there are varied estimation of GDP from studies conducted by different agencies. Gupta et al (2020) had prepared a report for McKinsey & Co. where it has been estimated that India’s GDP will contract somewhere between 43% and 51% in the current financial year. In another study, CRISIL estimated that 41% of the GDP is at risk with rate of growth to as low as 1.8% for 2020-21. Astonishingly, even this not the end. There are a few reputed agencies whose estimations are more daunting. The annual growth rate estimated by Goldman Sachs is -0.4%, by Normura is -5.2%, by Moody’s is 0%, by World Bank is 1.5%-4%, by Economic Intelligence Unit is 2.1%, by ADB is 1.8% and by S&P is -5%.[1] Even Reserve Bank of India has also acknowledged that under present circumstance there will be negative growth as only sluggish recovery can be expected. 

Here, the obvious question that strikes our mind is what is cause for which this contraction in the rising Indian economy took place. We will certainly explain the cause, but before that let us understand GDP, rate of growth of GDP and the vicious business cycle or the economic cycle.

The GDP

GDP or Gross Domestic Product is the total value of goods & services produced within the boundaries of a country. It is measured over specific time periods i.e. a quarter or a year. Throughout the world it is acknowledged as an economic indicator that portrays the economic health of a country. For middle-income and low-income countries, GDP growth is indispensable for meeting the rising demands of its citizens. GDP growth rate is the percentage change in value of total goods & services produced by nation within a given time period. The GDP growth rate, often termed as economic growth rate, is used for measuring the comparative health of an economy over time. It reveals in which stage among the four stages of the business cycle the economy is expanding, trough, contracting and is in peak. In India GDP is calculated by using two methods – GDP at factor Cost and GDP at market prices. GDP at factor cost is usually calculated to track the economic activity of the country while GDP at market prices is expenditure-based method. The expenditure-based method is indicative of the status of different sectors of the economy while which industry sector is performing well is revealed by GDP at factor cost. Further, real GDP is arrived after adjusting inflation while nominal GDP is calculated using the current market price. For calculation of GDPFC , the data is collected from sectors: forestry and fishing; hotel, trade, construction, transport and communication; social and public services; manufacturing; electricity and gas supply; mining and quarrying; financing, real estate and insurance; business and community services. For the calculation of GDPMC, all the spending incurred on final goods & services are added which include business investment spending, government spending, consumer spending and net exports.

The GDP growth rate shows positive figure there is expansion in the economy. A positive figure means there is growth in jobs, business and personal income.  According to economists, ideal growth rate remains between 2%-3%. It hits the peak if economy expands beyond this figure for too long. After reaching the peak the bubble bursts and economic growth stalls. This is the highest point of the business cycle. At this level the economy produces maximum output, employment is at or above full employment. In the market, inflationary pressures on prices becomes evident. Soon after reaching the peak, the economy typically enters into a correction and starts contracting. The businesses stop investing in new purchases. They stop hiring or employing new employees until they become optimistic about improvement in the economy. No new recruitment or delay in recruitment further depresses the economy. Consequently, unemployment increases due to lack to recruitment and subsequently the purchasing of the consumers reduces and they start spending less money. The pricing pressure starts subsidising. Then comes the fourth phase or the phase of recession. The GDP growth rate turns negative. The rate of growth in GDP becomes negative GDP is less than the previous quarter or year. The negative growth rate in GDP continues until it hits trough. At this point, the economy reaches the bottom from where it again starts to turn around and enters the phase of expansion when GDP turns positive again.

Now, assuming that we are able to clear the basics of GDP, GDP growth rate and the vicious business cycle, let us understand why this contraction happened in Indian economy while it was passing through the stage of expansion and was yet to reach the peak.

Contraction in Indian GDP

As already mentioned above, Indian economy suffered its steepest contraction of 23.9% in the first quarter of financial year 2020-2021 since it was first declared in 1996. This is the first time since 1996 that contraction occurred in the Indian economy in comparison with the same period in the previous year. The Governor of RBI, Shaktikanta Das, in his statement after the meeting of Monetary Policy Committee said that there is likeliness that the economy will face a contraction of 9.5% in the current fiscal year.

The contraction reflects excruciating impact of the lockdown imposed in response to the COVID-19 pandemic, which stalled most of the economic activities, and the slowdown trend of the economy in the pre-COVID-19 days. The nationwide lockdown had hollowed out demand. Railways best illustrates this decline. During the three months of lockdown days, count in passenger kilometres had reduced by 99.5% while the 26.7% was the decline in the amount of goods transported by the railways. With no manpower to operate the machines, manufacturing contracted by 40.7%, cement consumption declined by 38.3%, stell by 56.8%. Impact had fallen on the agricultural sector also due to slump in demand and freezing of trade & transportation. However, it was only the agricultural sector where a modest growth of 3.4% was observed in year on year terms. Horticulture, floriculture, poultry, milk and vegetables are some of the commodities that suffered the most. In terms of gross value added, steepest contraction was found in the construction sector (50%), while hotels, trade, transport & communication contracted by almost 47%.

Taking a look at the expenditure side, private consumption spending used to account for nearly 60% of the GDP. This spending declined by 26.7% as all discretionary spending were abjured by the consumers. One-fifth or 20% of the GDP used to come from exports. These exports which reflected demand for Indian goods & services in overseas market, declined by almost 20%. There was a 47% collapse in the investment activities thereby the shrinking the GDP share to 22% in comparison to pervious year’s 32% as big businesses opted to conserve cash stopped itself from capital spending due to uncertainty. On the other hand, there was an increase of 16.4% in the final consumption expenditure of the government.

The above figures clearly clarifies why and how the contraction happened in the India economy. Now, let us understand what this contraction implies or what impact it brings on our daily life.

The Repercussion

Contraction in the consumption percentage implies that people are buying in less quantities or in other words, they have cut down on consumption. So basically, this means people are spending less amount than before. This brings numerous impacts on the economy. First and foremost, the money people spend on buying something is the income of the business. Therefore, people spending less means a fall in revenue earnings which consequently is bound to bring huge impact on the employees. Here just recall about the numerous debates that we had come across during the lockdown days in various news channels on jobs losses, reduction in salary, almost zero increment to the existing employees and no new employment opportunities for the freshers or those who were fired as all expansion plans of businesses were put on backburner. All these topics came up from a single issue – reduced spending by the consumers.

Behind every statistic given above, there are millions of people below it. Hence, this enormous economic devastation is bound to impact all our lives. Let’s understand how this contraction is going to bring impact on us. Lets take an example to understand this in a lucid manner. Consider that it’s the first Sunday after your salary has been credited in your bank account. Since you have money in your pocket, you planned to go out for a movie with your friends or family at some multiplex. While watching the movie, you also bought popcorns and beverages. And after coming out of the hall, your eyes suddenly got paused at pair of shoes or say at some t-shirt which you bought eventually. And then you and your friends went to the food court to have some mouth-watering dishes before leaving for home. Now think of the economic activities that took place in the entire day. Every time a money is being spent by you it is entering into the accounts of the business man selling the product. This money will be utilised by the business man in paying shop rentals, salaries to his employees, payment to suppliers and the extra will be taken by him as profit. Everyone who gets receives money from the business man will now be able to go out and buy their essentials or go for a hangout like you did.

In economics this cycle is termed as multiplier effect of spending. During the lockdown days, when people were forced to stay indoors, this multiplier effect broke down massively. Consequently, it brought a further negative impact on jobs and spending. During the lockdown, companies were forced to allow their employees to work from home, but in the unlock phase what we saw was that companies were encouraging their employees to continue working from home. The economic impact of working from home are falling on those who works in the informal services sector. For instance, those who go to work place by car will no longer want to employ drivers. Hence jobs will be lost. Similarly, those using train as their means of transport, usually keeps their bikes or cycles at garages near to railway stations. As these people will not be going, income of the garages and people employed at the garages will also be lost. Moreover, there will also be a reduction in the demand for app-based cars. Thus, another loss of economic activity. Sadly, even this is not the end. Usually, there are many small eating hubs outside most of the Indian corporate parks which sells foods. Most of these small shops fully remains dependent on these corporate employees, who will also continue to lose out on business. Hence, the pandemic might end up destroying Pakodanomics as well.

In one of our previous articles titled “India’s Economic Crisis”, we had comprehensively discussed how slump in demand can severely damage India’s growth potential. The nation-wide lockdown just worked as a catalyst in intensifying the intensity of the damage. According to the Asian Development Bank (ADB) and International Labour Organization (ILO), almost 41 lakh youth in India have lost their jobs due to the COVID-19 pandemic. Out of these 41 lakhs, majority of the job losses were reported from farm and construction sector. Now what impact does these jobs losses bring to the economy? Just recollect the story we said while explaining the multiplier effect. There we saw how money gets transferred from one hand to another and how differently it gets utilized and benefits each one. Now think about the 41 lakhs youth losing their jobs. No job means no money and no money means no purchasing power. Hence, there will be a drastic fall in the demand as demand is the desire for any commodity backed by purchasing power. However, in beginning of the lockdown, the aggregate supply shock was higher than the aggregate demand shock as the lockdown had disrupted the domestic supply chain more than consumer spending. This disrupted supply chain brought shortage in the supply of goods which eventually hiked the prices of essential commodities. Although the output is gradually returning to the levels of pre-COVID-19 days, it is yet unlikely that things will normalise in this fiscal year. Thus, it is likely that prices of essential commodities will remain high throughout this fiscal year. This is also the reason why RBI predicted that Indian economy will contract by 9.5% in this FY20-21.

Several economists opine that the current decline in the output in addition to rising inflation will ultimately lead the country into a stagflation trap. They further says that the supply shock which the economy experienced during the lockdown will be replaced by a demand shock in the coming months. Guido Lorenzoni Northwestern Univerversity, Veronica Guerreri of the University of Chicago’s Booth School of Business, Ivan Werning of Massachusetts Institute of Technology and Ludwig Straub of Harvard University proposed the idea of paradoxical “Keynesian supply shock” or a situation where in the wake of initial supply shock, a deflationary demand shock gets created. According to these four eminent economists, a supply shock that affects various sectors of the economy asymmetrically will lead to a demand shock eventually in the presence of incomplete markets.[2]

What is the way out?

When suddenly the income of individual decreases, they reduce the consumption at first. And when there is fall is private consumption, businesses stops making any new investments. As both of these two are voluntary decisions, there is hardly any way of forcing individuals to spend more and/or coerce businesses to make further investment in the present scenario. The same logic holds for imports & exports also.

Under such circumstances, only government can boost the GDP by spending more – either by directly handing out money or paying salaries or through construction of roads and bridges. Similarly, in order to increase the consumption, Government can reduce the percentage of GST – for instance, the GST on two wheelers can be reduced to 18% from 28%. Though government will some taxes on per unit of sales, the increase in sales volume will make for it. Additionally, if the sales of two-wheelers increase, everyone from steel companies to tyre manufactures will be benefited.

Although, the expenditures made by the government increased by 16.4% between April and June yet there the expenditure needs to be increased more. In this context, government have put money into the Jan Dhan accounts of females. Its time that the same is done to male Jan Dhan accounts as well. Similarly, expenditures done through the Mahatma Gandhi National Rural Employment Guarantee Scheme has been increased by the government. It is crucial the government keeps providing work under the scheme throughout the year. However, all these needs more money. It must be noted that tax collection between April and July of this year have collapsed by almost 30%. Borrowing from Reserve Bank of India can be an option here. Nevertheless, it is essential for the government to increase its expenditure. Only this way the economy can revive in the short to medium term. Unless adequate expenditure is made by the government, it may take a long time for the economy to recover.

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[1] India’s GDP Mis-estimation: Likelihood, Magnitudes, Mechanisms, and Implications https://www.hks.harvard.edu/centers/cid/publications/faculty-working-papers/india-gdp-overestimate

[2] Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages? https://www.nber.org/papers/w26918

 

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