Double-digit slump isn't the end of the world, assures Arvind Panagariya

Economic Times, September 10 2020

The strict lockdown forced by Coronavirus during the bulk of the first quarter of fiscal year 2020-21 has translated in a sharp decline in the Gross Domestic Product (GDP). The latest estimates place year-on-year decline in GDP during April-June quarter at 23.9%. What this means is that if the economy were to shrink by this same percentage in the remaining three quarters, growth rate in 2020-21 would turn out to be -23.9%. Of course, no one is making such a dire prediction. C. Rangarajan, a former RBI Governor, has even written arguing that we cannot rule out the possibility of a small positive growth during the full year.

            Some commentators have tried to connect this decline to the steady decline in the quarterly growth rate from a robust 8.2% in the fourth quarter of 2017-18 to 3.1% in the fourth quartier of 2019-20. The argument these commentators seem to be making is that the large decline in April-June quarter represents fundamental weakness of the economy rather than the onslaught of Coronavirus.

            In my view, this is a wholly unwarranted inference. One could plausibly argue that even absent coronavirus the growth rate in April-June quarter would have been low. But claiming anything worse such as even a mildly negative growth rate in the absence of an external shock such as Coronavirus is patently absurd.

            Most economies that were hit hard by the virus and went into relatively strict lockdown have seen a sharp decline in their GDPs in April-June quarter. This is particularly true of Europe where the United Kingdom has seen its GDP shrink by 21.7%, Spain by 22.1% and Italy by 17.7% on year-on-year basis. Germany was impacted by the virus less and its GDP fell by 11.7%, year on year.

            The decisive role of Coronavirus onslaught in India can also be seen in the relative performance of different sectors of the economy. Sectors that were impacted the most by the lockdown also saw the sharpest decline. Thus, construction fell by 50%; trade, hotels, transport, communication and services related to broadcasting by 47%; manufacturing by 39.3% and mining and quarrying by 23.3%.

            Agriculture had been largely left out of the lockdown and it grew at its trend rate of 3.4% as if no interruption in economic activity had taken place. Financial, real estate and professional services, which had the greatest potential to operate online, saw a decline of only 5.3%. Electricity too saw a fall of just 7%. Public administration, defense and other services declined 10.3%.

            Given this relative performance of different sectors and the experience of other countries, it is hard to escape the conclusion that the decline in economic activity in April-June quarter is almost entirely the result of the strict lockdown. This inference is reinforced by some of the developments following the gradual lifting of the lockdown.

            For example, August month manufacturing Purchasing Manager’s Index (PMI) rose to 52 from 27.4 in April. Even PMI in services rose to 41.8 in August from 33.7 in June. Sales of electronic items have seen a 40% jump in August 2020 over their level in the same month the previous year. Trains to destinations such as Delhi, Mumbai and major cities in Gujarat, which play host to migrant workers, have been operating at 100% capacity.

            The Coronavirus has behaved in far too unpredictable manner. In the early months, it had appeared that Indians enjoyed some extra immunity against it compared with westerners on account of having been subject to other frequent viral infections in the past and having taken BCG shots for tuberculosis. But those hypotheses have now receded into background. Cities such as New York that had done initially poorly now look a lot better while the opposite is the case with cities that had done well in the early months. The same goes for India where early success has given way to a massive spread of the infection.

            Any near-term predictions on the economy are subject to this basic uncertainty. As long as the threat of the virus remains, a part of the workforce will hesitate to return to work and the economy would not return to full capacity. The flip side of this is that once confidence against the virus is restored through a reliable vaccine, we will see the economy return to its original growth path.

            Some commentators have expressed fears without adequate accompanying evidence or arguments that in the medium to long term India is now headed for the 1980s level of growth. I do not share these fears. In the last six years, a large number of economic reforms have been introduced and many more are under way. In my reading of the past evidence, growth effects lag behind policy actions by several years. Each year, we get closer to, not father from, the time when the effects of the reforms undertaken by the government will kick in. Therefore, with some careful management of the financial sector, I see excellent prospects of returning to 7 percent plus growth once the threat of Coronavirus is eliminated. If we also position ourselves well to take full advantage of the global market by opening the economy to foreign trade, we would grow faster still