January 24, 2021

‘Q2 GDP looks much better but no guarantee of improvement unless government spends more’

'Q2 GDP looks much better but no guarantee of improvement unless government spends more'

By Administrator_India

Capital Sands

The Indian economy contracted 7.50 percent in the second quarter of this financial year against a decline of 23.90 percent in the first quarter. Technically, the country is in a recession following two straight quarters of contraction but the slowdown is gradually easing.

The gross domestic product (GDP) growth is at an 11-year low, compared to 4.20 percent in 2019-20 and an expansion of 6.10 percent in 2018-19. It is to be understood that the slowdown in growth accentuated and converted itself into a recession, with the pandemic and the lockdown and the demand destruction that followed.

A return to normalcy was expected as soon as the situation improved, which was reflected in the slowdown in the sluggishness seen in the September quarter numbers. Contrary to the general expectation of a contraction of around 8 percent, the number at 7.5 percent looks much better but there is no guarantee of a sustained improvement unless the government spends more.

The Keynesian prescription for recession is pushing up aggregate demand through government spending. And it works. But one should draw comfort from the fact that GDP is better-than-expected and the number for the whole year could be somewhere between -7 percent and -8 percent, which would be a shade better than what has been forecast, so far. This also assumes that growth may be positive—at least mildly positive— in the coming two quarters.

While agriculture remains at 3.40 percent growth, other key sectors like mining, construction, hotels, transport and real estate remain in the negative mode. Some of these areas are labour intensive and their dependence on migrant labour is extremely high, like construction and real estate. Unless labour moves in, full recovery in these sectors may take more time.

A second and more critical threat to growth may emerge from rising inflation. The Consumer Price Index (CPI), as per the last reports, is at 7.61 percent and food inflation at 11 percent. Over the last couple of months, food inflation has spread to all major items apart from fruits and vegetables.

Something that is still more worrying is the rise in oil prices. Brent is edging closer to $50 per barrel and prices may not come down in winter. Higher oil prices may have inflationary impact unless some of the local taxes on fuel are brought down.

While inflationary pressures may persist for another two or three months, if they gets prolonged, then the Reserve Bank of India might act to contain the price level because the central bank may never be party to imposing a tax on the common man by way of higher price when they are already going through too much.

While central banks elsewhere are praying for higher inflation, whether it is the US or the EU, we will not be in a position to accommodate higher prices even for a short time.