India’s GDP growth contracts 23.9%: What is the economics behind the math?

Context: India’s GDP contracted by 24% per cent in first quarter (April, May, June) of 2020 as per the data released by the Ministry of Statistics and Programme Implementation (MoSPI).

Analysis

• In other words, the total value of goods and services produced in India in April, May and June this year is 24% less than the total value of goods and services produced in India in the same three months last year.
• As Chart 2 bears out, almost all the major indicators of growth in the economy — be it production of cement or consumption of steel — show deep contraction. Even total telephone subscribers saw a contraction in this quarter.
• In terms of the gross value added (a proxy for production and incomes) by different sectors of the economy, data show that barring agriculture, where GVA grew by 3.4%, all other sectors of the economy saw their incomes fall.
• Gross value added = GDP + subsidies on products – taxes on products.

What causes GDP contraction? Why hasn’t the government been able to curb it?

• In any economy, the total demand for goods and services — that is the GDP — is generated from one of the four engines of growth.
• The biggest engine is consumption demand from private individuals like you. Let’s call it C, and in the Indian economy, this accounted for 56.4% of all GDP before this quarter.
• The second-biggest engine is the demand generated by private sector businesses. Let’s call it I, and this accounted for 32% of all GDP in India.
• The third engine is the demand for goods and services generated by the government. Let’s call it G, and it accounted for 11% of India’s GDP.
• The last engine is the net demand on GDP after we subtract imports from India’s exports. Let’s call it NX.
• In India’s case, it is the smallest engine and, since India typically imports more than it exports, its effect is negative on the GDP.
• So total GDP = C + I + G + NX

What has happened to each of the engines in Q1?

• Private consumption — the biggest engine driving the Indian economy — has fallen by 27%.
• The second biggest engine — investments by businesses — has fallen even harder — it is half of what it was last year same quarter.
• So, the two biggest engines, which accounted for over 88% of Indian total GDP, Q1 saw a massive contraction.
• The NX or the net export demand has turned positive in this Q1 because India’s imports have crashed more than its exports. While on paper, this provides a boost to overall GDP, it also points to an economy where economic activity has plummeted.
• That brings us to the last engine of growth — the government. As the data shows, government’s expenditure went up by 16% but this was nowhere near enough to compensate for the loss of demand (power) in other sectors (engines) of the economy.

What is the way out?

• When incomes fall sharply, private individuals cut back consumption. When private consumption falls sharply, businesses stop investing. Since both of these 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 (G). Only when government spend more — either by building roads and bridges and paying salaries or by directly handing out money — can the economy revive in the short to medium term. If the government does not spend adequately enough then the economy will take a long time to recover.

What is holding back the government from spending more?

• Even before the Covid crisis, government finances were overextended. In other words, 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. Chart 4 by McKinsey Global Institute provides ways in which an additional 3.5 per cent of the GDP can be raised by the government.

This site uses Akismet to reduce spam. Learn how your comment data is processed.