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A modest and uneven economic recovery

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At 8.7%, the latest estimate of GDP growth from the National Statistics Office in 2021-22, although slightly lower than the 8.95% forecast at the end of February, is quite good given the headwinds that the economy has faced. The slowdown in growth in 2021-22 was due to a downward revision of estimates in the first two quarters of the year. However, these figures should be interpreted with caution, given the base effects of a 6.6% contraction in 2020-21. The quarterly growth figures for the first three quarters of 2021-22 are a mirror image of the contraction of the first two quarters of 2020-21, followed by a recovery in the third and fourth quarters. Inflation-adjusted GDP in absolute terms in the fourth quarter of 2021-22 was 107% of the pre-pandemic level (2019-20) and 91% in the first quarter.

At the general sectoral level, agriculture grew by 3% in 2021-2022, industry by 9.8% and services by 8.8%. The two sectors that contributed significantly to the moderation in growth in the fourth quarter were manufacturing (which contracted by 0.2%) and construction (which increased by 2%). Even taking into account the base effects of high growth rates in the corresponding quarter of 2020-21, the weakness is visible. The near-zero growth in the manufacturing sector is somewhat surprising, given the 22% growth in merchandise exports in the quarter, and may indicate weak domestic demand.

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A likely explanation is weak informal sector output, which is represented by the industrial production index, which rose 1.2% in the quarter. Equally concerning is the weakness in the construction sector, particularly real estate, where many projects have reportedly been delayed due to rising input costs.

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On the other hand, some service segments showed relatively strong growth. Most striking is public administration and other services—this segment grew by almost 8% and contributed about a quarter of the overall 4.1% growth in value added. This includes the universe of micro and small proximity services in education, health, leisure, etc., suggesting a strong recovery of contact services after the opening of economic activity.

The demand side of GDP, however, shows some inconsistencies. Government consumer spending increased by 4.8% and corresponds to the public administration segment. Private consumption, however, slowed, with growth in the fourth quarter falling sharply to 1.8% from 7% in the third quarter, which is at odds with the recovery of MSMEs. Investment in fixed assets, on the other hand, remained stable, even robust, growing by 5%, against 2% in the previous quarter. This was likely dominated by a massive 76% increase in Center capital spending (and to a lesser extent state capital spending). This is surprising given the weakness in the construction sector. One possible explanation is that private sector investment spending may have fallen sharply.

So why has the growth discourse become so important now? In the aftermath of an economic shock as large as the pandemic, quarterly GDP estimates are important indicators of the dynamics of economic activity and will be essential data for policymakers. But the growth trajectory for 2022-23 has become muddied by a host of economic, trade, financial and now geo-economic events, which are likely to linger.

In the near term, leading indicators of economic activity suggest that momentum in April and May, while slowing compared to March, remained surprisingly strong even in the aftermath of economic shocks emanating from the Ukraine crisis.

Our GDP growth forecast is 7.1% (very similar to the RBI’s earlier forecast of 7.2%). But the risks are now clearly tilted towards a slowdown in growth. First, input costs for manufacturers remain very high and have not been fully passed on to end consumers. Declining commercial viability has forced many businesses to scale back or even close their operations – the MSME segment would have been hardest hit.

Second, these supply shocks, which accelerated with the onset of Covid and then sharply worsened by disruptions to energy and raw materials from Ukraine and economic sanctions imposed on Russia, fueled prices in the whole world. Inflation in most developed countries is at its highest in several decades (helped by major fiscal stimulus packages in some countries). Most of the world’s major central banks have already begun to aggressively tighten monetary policy. These actions increased volatility in financial markets, which impacted emerging economies, including India. Consequently, India’s external environment is likely to be less benign than before.

Even before this tightening, global growth and trade were already expected to start to slow in 2022. India’s merchandise exports were a key driver of growth through the end of 2020-21 and in 2021-22, and this should moderate. Furthermore, RBI has shifted its focus from promoting sustainable and sustained growth to controlling inflation, increasing the repo rate and starting to drain excess funds injected during the pandemic. Lending rates have already increased for many borrowers, especially MSMEs and home loans, and a sharp increase in borrowing costs could put some pressure on the repayment capacity of weaker borrowers.

In nominal terms, GDP growth in 2021-22 was nearly 20% (vs. 8.7% real growth), driven by high WPI and CPI inflation. This wide divergence could further widen the gap in the distribution of discretionary income and consumption between household income classes. Although this will subside over the next couple of years as inflation cools, it has implications for the redistributive actions of economic policy, particularly fiscal.

In conclusion, while economic activity is recovering at a modest pace, many sectors and segments still appear to be constrained by weak demand and will require continued policy support. A coordinated policy response—fiscal, monetary, trade, industrial—will be needed to balance multiple macroeconomic policy objectives.

(The author is Executive Vice President and Chief Economist, Axis Bank. Opinions are personal)