India must brace itself for a long grind

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 India must brace itself for a long grind

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• First indication of contraction of economic activity: India’s real GDP growth in Q1 2021 shrank by 23.9% over the corresponding quarter last year. Biggest contraction ever, uncertainty caused by the pandemic, and a grim global scenario indicate a long slump. 
• Components of growth: Negative numbers are due to negative investment demand and industrial growth. 

1. Gross fixed capital formation, indicator of investment, declined by 89% and private consumption declined by 36.4%. But the government consumption spending increased by 16.4% indicating a huge revenue deficit and dent in savings. 
2. Production of capital goods, an indicator of investment demand, led to 64.4% fall in cumulative growth in April-June 2020.
3. Negative industrial growth (manufacturing, mining, quarrying declined by over 35%), slow agriculture growth and negative services growth contributed to negative gross value added (GVA) growth of 22.8% in Q1 2021 over Q1 2019-20. 
4. Negative services growth was due to -50.3% growth in construction and -47% growth in trade, hotels and transport. In the construction sector, decline in steel consumption (-57.9% in April-June) and cement production (-38.8% in April-June) were the key contributors of decline in growth. 

• Policies: 

1. In the absence of fiscal space, RBI injected liquidity of Rs. 5.76 lakh crore in 2019-20 and Rs. 3.09 lakh crore in Q1 2021 through conventional and unconventional monetary policy instruments.
2. It reduced the repo rate by 115 basis points in March and May. 
3. As part of the unconventional monetary policy of long-term repo operation, RBI injected liquidity of 4% for one to three years. 

• Liquidity injection and two critical issues:

1. Liquidity injection has led to monetization.
2. Credit demand has not picked up despite low bank lending rates.

• Distinction between monetisation and monetised deficit: 

1. Monetisation is when RBI receives government bonds as collateral and finances the liquidity injected by printing money. RBI purchases government securities in exchange for cash and receives interest income, net interest income is government’s dividend. 
2. Direct financing of government’s deficit is monetised deficit. This is prohibited now. 

• Investment and savings: Gross and net financial savings as a percentage of gross national disposable income increased in 2019-20 over 2018-19 because financial liabilities as a percentage of GNDI were lower. This indicates people and reducing debt. 
• Recovery: 

1. If the lockdown continues, non-availability of non-essential items will lead to a continued decline in consumption. Reduction in production capacities will lead to a decline in income. Overall consumption will thus contract and economic growth may continue to be negative through the year. 
2. Since infection hasn’t decreased and states that were not affected severely earlier are now seeing high rates of infection, lockdown could continue.
3. Uncertainties around the pandemic will also continue till there is a vaccine.

• Recovery: 

1. The economic crisis will be U-shaped given the uncertainty and risk of a prolonged health crisis. 
2. In the short-term, the focus should be on healthcare and vaccine and in the medium-term it should be productivity enhancement. 

• Summary: At -23.9%, India has recorded its largest ever reduction in real GDP growth over the corresponding quarter previous year. Negative investment demand and industrial growth are the key contributors to negative growth. Declining capacity utilization and weak consumption demand are limiting new investment. Revival of economic growth is directly related to lockdown. With the growing rate of infection, lockdowns are likely to continue and thus economic growth may remain negative for some time. 

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