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India’s GDP Contraction—Myths and Realities

GDP has shrunk from Rs 35.35 lakh crore in Q1 of 2019-20 to Rs 26.90 lakh crore in the first quarter of 2020-21, showing a contraction of 23.9 per cent as compared to 5.2 per cent growth in Q1 2019-20

—National Statistical Office, 31 August 2020.

23.9 per cent—This number has grabbed attention and induced panic among Indians across the country. It looked like a massive economic collapse was on the cards for the world’s fifth-largest GDP. How did India go from being the fastest growing economy to one struggling with a massive slump in its GDP? Is India going through a recession? Did the government erase years of economic growth in just one quarter? This article aims to address a few of those extremely pertinent questions.

THE ECONOMIC CYCLE

An economic cycle, defined as the fluctuation between expansion and contraction of the economy, has four main stages.

  • The expansion stage is when the economy experiences relatively rapid growth with low-interest rates, increased production and market expenditure, and mounting inflation.
  • The cycle touches its peak when growth hits its maximum, which upsets the system.
  • Slow growth, falling employment rates, and stagnating prices contribute to contraction and correcting those imbalances.
  • A trough is said to occur when an economy hits its nadir and begins to grow again.

Contractions are part and parcel of the economic cycle, albeit unpleasant. Recessions, however, comprise two-quarters of successive contractions, whereas depression is a more profound and long-lasting contraction. To put things into perspective, the USA has undergone 33 periods of recession while only one Great Depression, since 1854.  

Image Credits: www.economicshelp.org

GDP AS A BENCHMARK FOR CLASSIFICATION

The Gross Domestic Product (GDP) is a representation of the total value of all goods and services produced by an economy over a specific period. Contrary to public perception, the GDP does not represent the wealth in a country. Instead, it is often the most important yardstick to measure the total size and health of an economy.

GDP growth rate and GDP per capita are the most significant indicators of the monetary well being of a country. GDP growth rate, a comparison of the GDPs of two successive quarters, measures how fast an economy is growing. The GDP per capita, on the other hand, measures the value of goods and services produced per person of the population.

A nation’s GDP can be measured in three different ways.

  • The income approach—adding up what every person has earnt in a year.
  • The expenditure approach—adding up what every person has spent in a year.
  • The production approach—adding up the total consumption, government spending, investments, and net exports of a country

GDP as calculated using the production approach. Image Credits: Investopedia

Even though the GDP—which paints a comprehensive financial picture of a nation—is the most preferred gauge to classify countries economically, it has its shortcomings. More often than not, by the time the GDP of a particular quarter is declared, the nation is well into the next quarter. GDP often relies on official data and may not include unofficial income sources like household productions and money involved in intermediate transactions. Apart from geographical limitations in a globally open economy, the GDP emphasises economic output, turning a blind eye to the various negative impacts GDP growth might have on the country and its citizens.

THE BIG CRUNCH

India has two methods of calculating its Gross Domestic Product—one based on economic activity (at factor cost), and the other on expenditure (at market prices).

The factor cost method assesses the performance of eight different industries—broadly classified into agriculture, mining, manufacturing, electricity, construction, tourism, finance, and community industries. This method makes it easy to see the performance of an economy’s subsectors. The factor-cost calculated figure is what the media reports to the entire nation. The expenditure-based method, on the other hand, indicates how different areas of the economy, such as trade, investments, capital gains, exports, and personal consumption are faring. It offers useful insights into which domains contribute the most to the Indian economy.

Image Credits: Press Trust of India

Most analysts around the globe were expecting the shocking news of India’s economic contractions in April, May, and June. Contrary to popular belief, one-quarter of the economy did not just vanish, and the GDP did not plummet to negative values. A contraction of 23.9 per cent means that the total value of all goods and services fell by that proportion as compared to the same three-month period last year. The economic output of the summer of 2020 was much lesser than the summer of 2019, thanks to the pandemic. Government data indicates that except for agriculture—which grew at a rate of 3.4 per cent—every other sector of the economy has contracted.

The factor cost method rendered figures showing the growth of the agriculture sector by 3.4 per cent. In contrast, sectors like mining, construction, trade, hospitality and other services, and manufacturing witnessed a steep decline in their economic well beings. However, the expenditure-based method indicated a drop of 27 per cent in private consumption of goods and services. Investment into the private sector falling by Rs 5,33,003 crores combined with the reduced consumption contributes to 88 per cent of the GDP shrinkage. The significant drop in exports only added to the damage meted out to the economy.

India can potentially be classified as a country experiencing recession based on its performance in the second quarter, i.e. July, August, and September. Considering that manufacturing, tourism, construction, and numerous other day-to-day activities are still not back in action, it is very likely that India will receive the recession tag, like many major countries in the world.

A PEEK INTO THE FUTURE

Moody’s Investors Service has predicted that India’s GDP will contract by 11.5 per cent in the fiscal year 2020-21, much higher than its previous estimate of 4 per cent contraction. However, they also believe that growth will rebound to a minimum of 10.6 per cent in 2021-22, as economic activity normalises slowly but surely.

Image Credits: https://www.economicshelp.org/blog/1599/economics/cyclical-economic-activity/

The pandemic has slowed down economic growth worldwide. Sporadic outbursts of the disease in various places in the country have forced regional or nationwide lockdowns, curbing all activities. Key sectors that drive employment of the masses have been struggling to keep themselves relevant in the market. Amidst the desperation to get things back to normal, economic soothsayers predict that the current phase is just another trough in India’s economic cycle, and India is all set to tread the path of economic expansion once again.

Written by: Raghukrishnan J, of The Economics and Finance Society of Manipal

Edited by: Parthiv Menon, of The MIT Post

Featured image credits: ESOM

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