Economy bottoming out; rebound not broad-based

The Reserve Bank of India’s Monetary Policy Committee (MPC) has decided to keep policy rates unchanged while retaining an accommodative stance. It also believes that the economy is already out of contraction zone and will register positive growth in the quarters ending December (0.1%) and March (0.7%). This means that the Indian economy has bottomed out from its pandemic shock. The fact that MPC expects the annual GDP contraction in 2020-21 to be 7.5% and not 9.5%, a number it projected in its October meeting shows that the recovery has been faster than expected. However, evidence from the latest forward looking surveys of RBI also shows that the possibility of a deceleration in the ongoing recovery cannot be ruled out. MPC’s assessment also indicates that the nature of challenge facing the economy could actually be shifting in nature from the immediate task of ensuring an unlocking of the economy. Here are four things worth keeping in mind while looking at the economy going forward.

1 Base effect will make growth rate numbers a bit misleading in the future

The Indian economy was losing growth momentum even before the pandemic inflicted a huge disruption to economic activity. GDP growth was 8.2% in March 2018. It fell continuously in all quarters until June 2020, except in March 2019. GDP growth was 4.1% in the quarter ending December 2019 and just 3.1% in March 2020. The June and September quarters have seen an annual contraction in GDP. Going forward, this will have a favourable base effect on GDP growth rates.

 

This means that disproportionately higher growth rates need not mean that the economy is adding to its historical incomes at a very fast pace. For example, even with a 25% growth rate in the quarter ending June 2021, the absolute GDP level would still be lower than the June 2019 level.

2 Consumer Confidence Surveys show an unequal recovery

While the overall economy is supposed to be out of the contraction zone, this has not translated into an increase in incomes for majority of the population. The latest Consumer Confidence Survey (CCS), which was conducted in the first half of November shows that more than half of the respondents continue to report a fall in income and employment.

 

While perceptions about general economic situation and employment seem to have bottomed out, incomes and non-essential spending have fallen compared to September levels. This suggests that the ongoing economic recovery is being driven by a small section of the economy. Experts have been talking about the current economic recovery being led by profits rather than wages, which could put a squeeze on mass demand going forward. To be sure, CCS is conducted in urban centres and does not capture the mood in rural areas -- and by all accounts agriculture is doing well.

3 Inflation is moving beyond food items

MPC has struck a note of caution on the inflation situation, which has begun to percolate outside food items. A good winter crop might not be enough to bring down food inflation which has entered double-digit growth since September.

 

“While cereal prices may continue to soften with the bumper kharif harvest arrivals and vegetable prices may ease with the winter crop, other food prices are likely to persist at elevated levels”, the MPC resolution noted. Higher food prices will continue to put pressure on household budgets and adversely affect non-food demand. Consumer Price Index (CPI) data shows that core inflation – the non-food non-fuel component of CPI basket – has been steadily rising in the past few months along with food inflation.

With international crude oil prices firming up on expectations of a global revival in demand, the government might have to reconsider its high taxes on petroleum products as well. Brent crude prices ($48.7/barrel on December 3) have regained March levels .

4 Will credit growth pick up?

A lot of experts believe that the better-than-expected performance in the September quarter was a result of a favourable confluence of pent-up demand and festive demand. Speaking at the Hindustan Times Leadership Summit, finance minister Nirmala Sitharaman said that while these factors might have played a role in the economic recovery, businesses have started planning for fresh investment and the recovery will gain more strength.

 

A good way to check whether or not this is happening would be to track the demand for non-food credit in the economy. Latest data from the Centre for Monitoring Indian Economy shows that non-food credit growth seems to have bottomed out and has started recovering in November after having fallen for a long time. If this recovery sustains itself going forward, it could be an early indicator of revival in business sentiment and perhaps investment demand.