Decoding India’s GDP Contraction

The contraction seen in first quarter GDP data is severe, but not expected. Most observers expected that India’s GDP contraction would not exceed 20% in the first quarter ( April, May, June). But it turns out that the GDP contracted by 24% in the first quarter. The data quality is suboptimal because of the widespread lockdowns. With GDP contracting by more than what most observers expected, it is now believed that the full year GDP could also worsen when it is revised in due course. Since economic liberalization in the early 1990s, Indian economy has clocked an average of 7% GDP growth each year; but this year, it is likely to turn turtle and contract by 7% for the full financial year. Data shows that barring agriculture, where the GVA grew by 3.4%, all other sectors that creates the maximum new jobs in the country such as construction (-50%), trade hotels and other services (-47%), manufacturing (-39%) and mining (-23%) saw their incomes fall. In a scenario where each of these sectors is contracting so sharply, it would lead to a rise in unemployment.
In any economy, the GDP is generated from one of the four engines of growth. The first engine is consumption demand from private individuals, second is the demand generated by the private sector business, third is the demand for goods and services generated by the government, which accounted for 56.4%, 32% and 11% respectively of all GDP in India before this quarter. The last smallest engine is the net demand on GDP after imports are subtracted from India’s exports. Since India typically imports more than it exports, it’s effect is negative on GDP. When incomes fall sharply, private individuals cut back consumption. When private consumption falls sharply, businesses stop investing. Since both are voluntary decisions, there is no way to force people to spend more and/or coerce businesses to invest more in the current scenario. The same logic holds for exports and imports as well. Under the circumstances, there is only one engine that can boost GDP and that is the government. Only when government spend more, can the economy revive in the short to medium term.
Even before the COVID-19 crisis, government finances were overextended. It was not only borrowing but borrowing more than what it should have. As a result, today it doesn’t have as much money. It will have to think of some innovative solutions to generate resources. The economy, is therefore, far from normal, and may stay that way for a while.

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