Recession’s here, downside risks abound – FY21 may see a de-growth of 5%

Discretionary consumption in urban areas is not expected to recover swiftly, as evidenced by the plunge in consumer confidence recorded after the lockdown was imposed.

The provisional estimates released by the Central Statistics Office (CSO) revealed a considerable deceleration in the growth of Indian gross domestic product (GDP) to 4.2%, an 11-year low, in FY20. This level was around half of the previous peak of 8.3% recorded in FY17, a sobering statistic.

What was starkly evident from this data, was that the slowdown in the growth of Indian economic activity had become entrenched well before the Covid-19 outbreak. This has assumed particular importance in the current context, as we attempt to quantify the impact of the pandemic on the outlook for GDP in FY21 and beyond.
So far, we have some data for the lockdown period of April-May 2020, and limited evidence for the unlock period in June 2020.

Core sector and overall factory output contracted by 38.1% and 55.5% in April 2020, as the lockdown expectedly shuttered various production facilities. There was, however, a wide variation in how the various sub-sectors performed. Essentials, electricity and mining witnessed the least disruption, while industries in the consumer durables, capital goods and construction goods sectors generated marginal output in April 2020.

The starkest hit were auto production and travel, with severe restrictions imposed on air and rail passenger movement in that month.  Available data for May 2020 confirms that year-on-year (y-o-y) performance of a majority of the early economic indicators marked an improvement in that month relative to the trough in April 2020. However, the pace of recovery was uneven, which is expected to have continued in June 2020 as well. For instance, the y-o-y de-growth in electricity generation has narrowed appreciably in the later part of June 2020, mirroring the gradual reopening of the economy. The contraction in merchandise exports is reported to have eased significantly in June 2020, from the levels recorded in the previous two months.

Moreover, rural sentiment is assessed to be buoyant in line with the favourable outlook for the kharif season. The monsoon season recorded a timely onset, and the rains progressed rapidly across the country. The overall magnitude and spread of monsoon precipitation is expected to be normal in 2020. Benefitting from favourable moisture conditions, seasonally high reservoir levels, and returnee labourers at least in some parts of the country, kharif sowing was twice as high as the year-ago level, as on June 26, 2020. We are hopeful that agricultural gross value added (GVA) will be able to record a 3.5-4.0% expansion in FY2021, boosting rural sentiment and consumption.

However, discretionary consumption in urban areas is not expected to recover swiftly, as evidenced by the plunge in consumer confidence recorded after the lockdown was imposed. This portends deep contraction in sectors such as travel and tourism, construction and non-essential manufacturing in Q1 FY2021, with a graduated recovery thereafter.

The outbreak and the ensuing lockdowns have certainly plunged the Indian economy into a recession, which is defined as two consecutive quarters of a contraction in GDP. Our base case projects a y-o-y decline of around 25% and 2%, respectively, in Q1 FY21 and Q2 FY21, followed by a mild growth of 2% and 5%, respectively, in the subsequent two quarters. This results in a full-year contraction of 5% in the ongoing fiscal. Subsequently, the pace of economic growth in FY22 is pegged at an optically robust 7.5-8.5%, benefitting from the base effect related to the expected contraction in FY21.

Our base case had assumed a lifting of the lockdown restrictions in Q1 FY21. While we have entered the unlock stage, we are moving into Q2 FY21 with no plateauing of new Covid-19 infections in sight. The localised lockdowns imposed in some states/cities are challenging our assumptions regarding the pace of the recovery from Q2 FY21 onwards.
The growing likelihood of continuing labour supply mismatches in major production centres, behaviour changes and deferral of discretionary consumption amid continuing economic uncertainty, pose downside risks to our baseline forecasts for the rest of the fiscal year. The retreat of these risks is partly predicated on the unknown timing of when a vaccine would become widely available.

Another risk is the government expenditure restraint engendered by the sharp revenue shock being faced by the Centre and state governments, even as targeted expenditure has been announced by the former.  If these risks get firmly entrenched, then we would certainly expect a weaker economic performance in FY21, clouding the outlook for FY22.

Coming back to where we started, the downtrend in economic growth between FY17 and FY20 suggests that India’s potential growth itself has likely whittled down to 5.0-5.5%. This is where we fear economic growth may settle, after the pandemic is behind us.