New normal for Indian economy entails push towards supply chain resilience & digital technology
After the sharp fall in GDP in the first quarter, projections indicate that India’s economy is expected to return to positive growth only in 2021-22. While Dr Sunitha Raju, Indian Institute of Foreign Trade is positive about the improvement in Business Expectation Index, she urges for strong support of employment multiplier sectors that are severely affected by the COVID-19 pandemic. Going forward to the new normal, digital technologies have far reaching implications for B2B, B2C and B2G services. There is an urgent need for immediate upgradation of skills and moving away from conventional educational systems and methods.
IBT: India’s GDP decline in the June quarter by 23.9% has been worse than projections. What are the main areas where the economy has fallen short of the already weak expectations and why?
Prof Sunitha Raju: With the onset of the COVID pandemic in India in March 2020 and the complete lockdown that followed for 66 days, GDP was expected to decline. Given the extent of contraction (even though based on quarter-to-quarter growth rate) it raises the question of whether this contraction is purely attributable to COVID or other factors, particularly in the context of lower contraction in other Asian countries: Singapore (– 13.2%), Thailand (-9.7%), Malaysia (-13.2%) and Philippines (-16.5%).
Major contributors for the 23.9% contraction in GDP are the decrease in construction (-50.3%), trade, transport, etc (-47%), manufacturing (-39.3%), mining (-23.3%) and public administration, defence (-10.3%). The only positive is agriculture at 3.4% (MoSPI). While the nation-wide lockdown would have resulted in this contraction, but the extent of decline in major economic activities points to a decline in economic activities from 2018-19 onwards.
The consistent fall in the GDP growth from 7% in Q1, 2018-19 to 3.6% in Q4 of 2019-20 brings into focus the down trend in major economic activities. Between 2018-19 and 2019-20, the growth rate of industry decreased from 4.5% to 0.8 % (compared to 6.8% in 2017-18), of which the growth in manufacturing decreased from 5.7% to 0.0%. During the same years, services decreased from 7.5% to 5%, of which the decline in construction was from 6.1% to 1.3% and that of trade, transport, etc was from 7.7% to 3.6% (RBI, 2020).
The correlation between the significant decline in growth in construction, trade, transport and manufacturing since 2018-19 and the drivers for Q1 (2020-21) GDP contraction is evidently very strong. This would imply that the onset of the declining trend is much before COVID, which only accelerated the trend.
Let us take a quick look at the factors leading to this declining trend in major economic activities, evident from the expenditure side of GDP estimates. During 2018-19 and 2019-20, private final consumption expenditure decreased from 7.2% to 5.3%, gross fixed capital formation decreased from 9.8% to -2.8%, exports decreased from 12.3% to -3.6% and imports decreased from 8.6% to -6.8% (RBI, 2020).
In other words, falling consumer demand is an indication of falling income, mainly a fall out of employment. The fall in government expenditure towards infrastructure and other capital expenditure would adversely impact construction, trade and transport, thereby impacting consumer income/expenditure. Broadly, these trends have also been confirmed by RBI analysis.
The three quarter moving average of seasonally adjusted annualized growth rates corroborated the weakening of the momentum of demand. Consequently, the negative output growth (i.e., deviation of actual output from the potential output) widened in 2019-20, pointing to the substantial slack in resource utilization.” (RBI, Annual report, 2020, p 21).
In other words, demand contraction resulted in a fall in GDP over the last two years. This fall in consumer demand would also affect manufacturing, which was further aggravated by the fall in exports/imports. imports.
IBT: How do you view the pace of the recovery given the numbers emerging post June in terms of manufacturing, services, infrastructure, consumer demand, farm activities, consumer demand, foreign trade, investments (public and private), etc? What do you view as the key drivers of a possible economic revival in coming quarters?
Prof Sunitha Raju: Factoring in the disruption caused by COVID, forecasts for India’s GDP growth for FY 2020-21 by RBI indicate a positive growth only by Q4 2020-21. By Q4 2021-22, GDP growth is expected to be about 3%. OECD (under single-hit scenario) has projected a negative growth of -3.7% in 2020-21, largely accounted by the negative growth in private consumption (-4.8%) and gross fixed capital formation (-14.5%).
Positive growth in GDP can be expected in 2021-22 at 7.9%, provided private consumption growth increases to 6.7%, GFCF growth rises to 17.2%, export growth is at 9.6% and import growth is recorded at 10.9% (OECD, June 2020).
Despite the variations in the projections, positive growth is expected only in 2022. For this recovery, sustained increase in private consumption is necessary, which in turn would depend on income and employment. With unemployment rising to 25% (urban and rural) following COVID, increasing consumption expenditure would necessitate income transfers/ food transfers until employment picks up.
While self-employed and regular salaried employees may not require significant income support, casual labour needs to be supported. High concentration of casual labour is in construction (42%) and agriculture (43.6%). Therefore, if government investment in infrastructure is resumed, unemployment levels can be restricted, thereby boosting private consumption.
The average structure of private consumption expenditure is skewed towards services (52%) that covers education, communication and non-durable goods (37.5%). Semi-durable and durable goods account for only 11%. As such, promoting food & beverages and services should be the priority. Secondly, manufacturing and trade and hotels have a large proportion of self-employed and regular employees along with casual labour. Therefore, reviving manufacturing will not only support employment but can also sustain consumption expenditure.
And thirdly, MSMEs provide employment to more than 114 million and contribute about 30% of GDP. The three-month moratorium on loan payment did provide support to this sector but resuming business would require assistance in working capital, logistics etc.
With the global GDP projected to decline by 4.9% and trade volume by 11.9% (IMF, 2020), impact will not only be in terms of lower demand, but also result in supply chain disruptions, restrictions in trade policies and fluctuations in commodity prices. Although there may be a deterioration of overall export performance but the deterioration is expected to be high for textiles, rice, gems & jewellery, engineering goods and petroleum products (RBI, 2020). Therefore, revival of manufacturing would largely depend on the domestic market in the short run.
IBT: What is your outlook on India’s economic growth trajectory in the current fiscal year? What are the downside risks that could impact this projection?
Prof Sunitha Raju: To address the economic distress caused by the pandemic and the subsequent lockdown, the government announced a package of measures in 5 tranches in May 2020 covering rural employment generation, infrastructure, MSMEs, NBFCs, migrant workers and ease of doing business. These measures amount to Rs 20,000 crore or 10% of GDP and address both short-term and long-term objectives. A quick of review of the stimulus measures in protecting the economically vulnerable people will enable a fair assessment of the growth trajectory.
As per the estimates of CMIE and University of Pennsylvania, 84% of the households have seen a decrease in their incomes. Rural households are impacted more relative to urban households. Lower and middle segments of income distribution are most severely affected. Unemployment rate, which has crossed 27% in May, improved to 24% in subsequent months. Under these conditions, food and income transfers are needed to prevent a sharp increase in malnutrition and deprivation.
The stimulus package covered direct transfers to women with bank accounts (204 million), old age/widows pension (30 million), income support to small and marginal farmers. In addition, 800 million households will get free food grains and 83 million households will get cooking gas for three months. But these may not reach many urban households due to lack of documentation requirements. Further, the direct cashflow of all these cash outflows may amount to Rs 920 billion or 0.7-1.3% of GDP (Business News, May 15 2020).
McKinsey’s estimates for supporting 32 million livelihoods and the NPLs by 7 percentage points (SMEs) would require Rs 10 lakh crore or 5% of GDP (also see IMF, August 27, 2020). However, as a large part of the stimulus package has been either credit guarantee programs or new fund creation to be shouldered by banks and financial institutions, the effectiveness is not clearly evident.
Considering the magnitude of the support measures across households, migrants and small businesses, administrative issues – identifying and delivering – would be a challenge. To boost the demand beyond the support provided, broad-basing the target households is necessary. One of the considerations for this would be to extend the income support to informal/contractual employees associated with companies, businesses and other economic activities.
With the digital identity infrastructure in place – Aadhar – effective measures of direct support can be designed, including PMJDY, PM-KISAN and MGNREGA beneficiaries. Concessions to home buyers can boost the real estate market, thereby creating jobs. And effective ways of providing liquidity lines to SMEs either through refinancing or loan programs can be structured. Distressed sectors like logistics, travel, auto textiles and construction should be given the priority. Partnering with state governments and local institutions would make these support measures effective.
If all these measures are made effective, consumer demand can be revived, which will support the positive growth trajectory from FY 2021. Alongside, government investment in infrastructure projects should be increased and the decline over the last two years needs to be arrested.
IBT: Government spending is a critical aspect of economic revival. But given that fiscal deficit has exceeded the budgetary target in 4 months, what are the options in front of the government?
Prof Sunitha Raju: The macroeconomic consequences of implementing such a wide stimulus package are many, particularly when the government is constrained for finances. The difficult choice present for the government is between external and internal debt. As public debt is largely through market borrowings, higher debt can lead to crowding out of private investment with the resultant pressure on inflation.
The debt/GDP ratio has already crossed 72% and is expected to reach 84% in 2021, thereby raising the issue of sustainability. However, if the utilization of the debt is largely for infrastructure investment, then the issue of sustainability would not be a major concern. But under the current pandemic situation, income transfers and subsidies are necessary to revive the domestic consumption expenditure and as such, the focus should be on employment generation and output growth even at the risk of crossing the inflation targets.
IBT: Some experts have expressed a fear of possible stagflation? How does the scenario for this look in your view, and what steps do you suggest to keep inflation and unemployment numbers under control?
Prof Sunitha Raju: The global price situation was subdued due to low crude oil prices and slight hardening of food prices. In India, with a positive growth in agriculture output, particularly food grains and horticulture, the food price inflation can be controlled with logistics and marketing support. The reforms taken up to facilitate the easy transportation of food across the country (withdrawal of ECA) to ensure better prices/income to the farmers should be able to check food price inflation, if supply chain disruptions are avoided.
Maintaining higher output will ensure employment of resources, which in turn can revive the consumer expenditure. This, to a large extent, also addresses the supply side issues like low capacity utilization of industries and prop up the investment demand. Assuming that construction activity picks up, then the investment demand for cement, steel and capital goods will increase and the multiplier effects will bring in higher incomes and consumer demand. Under these conditions, there will be growth and inflation will not be an issue.
IBT: When and how do you see the element of discretionary consumption stepping back into the equation?
Prof Sunitha Raju: As discussed earlier, the revival of output/income after the pandemic plateauing, is dependent on a number of assumptions on the effectiveness of the stimulus package, revival of consumer demand and supporting supply side developments with infrastructure and liquidity. Naturally, together these will raise real incomes, which in turn can push up the discretionary consumption. With so much of uncertainty, it is difficult to predict when and how this will take place.
However, the improvement in the business sentiments is a good sign. The Business Expectation Index (BEI), which was 102.2 in January 2020, increased to 105 in April-June 2020. Similarly, the PMI (Purchasing Manager’s Index) increased to 52 in August compared to 46 in the previous month. The services PMI increased from 34.2 in July to 41.8 in August. All these point to expansion in economic activity (manufacturing and services) and a rise in consumer demand.
IBT: What manufacturing/services sectors should be in focus from a policy perspective to hasten the revival in your view and why?
Prof Sunitha Raju: As a priority, we should first promote the sectors with large multiplier effects and employment potential. To a large extent, these are also the distressed sectors in the COVID times, namely, construction, travel, power, textiles, auto and the core sectors like steel, cement and capital goods. As per the IIP index forecast for 2021, the largest fall (over 50% decline) is expected in beverages, textiles and apparel, basic metals and fabricated metals, computer & electronics and electrical equipment, machinery and motor vehicles and transport vehicles. These manufacturing industries should be addressed.
From the use based classification, capital goods has a significant fall which needs to be addressed. Industry specific analysis of policy support is detailed in KPMG’s “ Potential Impact of COVID 19 on India” (April 2020).
But more important is adjusting to the ‘New Normal’ that entails developing supply chain resilience and digital push. While adapting quickly to the digital channels for higher efficiencies, investment in enabling technologies like cloud, data and cyber security has become critical.
These developments have far reaching implications for B2B, B2C and B2G services. E-commerce, e-governance, process automation and data analytics are becoming increasingly relevant, which needs immediate upgradation of skills and moving away from conventional educational systems and methods.
Dr. Sunitha Raju is a Professor at IIFT. She has 30 years of extensive experience in Education, Research, Policy formulation and Evaluation and held the positions of Chairperson (ICCD), Chairperson (Research) and Chairperson (GSD). Her areas of expertise include Trade Policy Formulation & Evaluation, Trade modelling, Agricultural Policy Analysis, WTO rules & Regulatory framework, Free Trade Agreements, Survey Research, Performance Reviews, Training & Management Development Programmes.