Economy

Understanding recovery during economic volatility

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India Ratings and Research (Ind-Ra) believes policy making is facing the twin challenge in collating reliable high frequency data and interpreting the same, as the impact of the COVID-19 pandemic is proving to be an unprecedented disaster. An appropriate understanding based on reliable data is critical to ensure effective policy intervention. The agency opines that during the period of shocks/volatility, such as the one caused by the COVID-19 pandemic, understanding the economic performance in level terms provides better insight than analysing year-on-year (yoy) performance.

On a yoy comparison, base (adverse or favourable) plays an important role in determining the growth performance. Therefore, any abrupt/abnormal movement in the magnitude of the variable in either direction can lead to a yoy change, which could be more of an outlier than a normal number. Taking the example of 1QFY21, which was impacted by stringent COVID-19 led nationwide lockdown. During this period Gross Domestic Product (GDP) and Index of Industrial Production (IIP) declined 23.9% yoy and 35.9% yoy, respectively. However, the pace of contraction reduced to 7.5% yoy and 5.9% yoy, respectively, in 2QFY21. The GDP and IIP growth suggest a strong V-shape recovery, leading to a belief that the economy is out of the woods and on the path of a strong recovery. Even a moderate improvement in 1QFY22 and 2QFY22 reflects a decent yoy GDP and IIP growth due to the low base. In fact, due to the low base of FY21, the full year GDP growth of FY22 on a yoy basis is expected to do fairly well. Ind-Ra’s GDP growth projections for FY22 is 9.6%. Most of the other agencies have also projected a high single-digit/low double-digit GDP growth number for FY22.

The projected GDP growth does indicate that the worst is over, but it still does not indicate whether the economy has recovered the lost ground and/or surpassed it.  

According to the National Statistical Office data, the size of the Indian economy in FY20 was INR145.66 trillion at 2011-12 prices. As per Ind-Ra’s projection, it is expected to contract 7.8% yoy to INR134.33 trillion in FY21 and grow 9.6% yoy to INR147.17 trillion in FY22. In yoy growth terms, although FY22 would appear to be an extremely good year, but in level terms it would only be slightly better than FY20, with output merely about 1.0% higher than FY20 level. This suggests that the economy will be able to just recover the lost ground in FY22 and surpass the FY20 GDP level in a meaningful way only in FY23.

Another way of assessing the GDP recovery is to assume the absence of the COVID-19 pandemic. Assuming a modest GDP growth of 5%, each, in FY21 and FY22, the size of the economy in FY21 and FY22 would have been INR152.9 4trillion and INR160.59 trillion, respectively. Based on the above calculation, even with a 9.6% GDP growth, the size of the economy in FY22 would reach only INR147.17 trillion, due to the COVID-19 pandemic. To achieve INR160.59 trillion would require a GDP growth of 19.5% in FY22, which is an impossible task. This shows the enormity of the loss to the economy, which gets obfuscated in a simple yoy growth analysis. If this output loss is converted into loss in consumption demand and employment, the damage to the economy may appear even bigger.

Also, removing seasonality and then analysing economic data is a better way especially during the times of volatility. However, this requires applying econometric/ statistical techniques to clean up the data. An easy way out is to index data at pre-shock level (February 2020 for monthly data) and analyse how far the economy has progressed after the lockdown was lifted.

The recently-released IIP data shows that factory output grew 3.6% yoy in October 2020. However, in level terms it was still 95.8% of pre-COVID level that is February 2020. Similarly, mining activities were 79.5% and manufacturing was 97.4% of the pre-COVID level. Only electricity generation at 105.5% surpassed the pre-COVID-19 level. The lagging sub-groups of mining and manufacturing would have to have grown at 9.2%, and 2.8% respectively in November 2020 to reach pre-COVID level. Similarly, an analysis of use-based classification of IIP shows that only one subgroup consumer durables (12.84% weight) surpassed pre-COVID-19 output level.

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