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Is the economy out of the woods?


GDP growth of 8.7% for 2021-22 may be one of the fastest rates in the world, but in absolute terms it only brings the economy back to 2019-20 levels. It may also suggest resilience, particularly if we examine how the individual components have evolved in a supply (GVA) and demand (GDP) format.

The contraction in supply in 2020-21 was generalized (excluding agriculture) and obviously due to the constraints imposed by the pandemic, the war or even the climate. The recovery in 2021-22 reflects the easing of some of them, besides of course the low base effects.

On the demand side (GDP), the fall seemed more likely due to the contraction in economic activity in 2020-21 than any long-term drop in income, which is also supported by the fact that the recovery is came with the resumption of economic activity.

This is clearer when we look at the individual components of demand. The 5.4% drop in private consumption, the main driver of growth, was due to lower spending on personal transport (-14%) and transport services (-24%) rather than food , which is the most important item of consumption. . In fact, food expenditure increased (4%) despite the drop in income, in particular due to government assistance measures.

Demand for services also fell (-9 percent), reflecting the overall contraction in economic activity, particularly in the so-called “contactless” sectors.

As for the other major driver, private investment, it was down even before the pandemic and has continued to fall (-12.7%). Net foreign trade has always had a disproportionate impact on GDP relative to its share, due to the fact that trade deficits are subtracted from GDP.

Thus, the sharp decline in the deficit in 2020-21 (-39.1%) helped to mitigate the decline in GDP. But strikingly, as things calmed down in 2021-22, imports, dominated by oil, jumped 35%, leading to a 127.5% increase in the net trade deficit. Finally, net government taxes also fell sharply (-24.9%) in 2020-21, leading to a larger decline in GDP than GVA, since taxes separate the two ( See the table).

There is a common link in all these components, viz. energy, especially oil, which now has a pervasive influence. On the one hand, petroleum and energy products now represent around 18% of private consumption expenditure (growing on average 10% before the pandemic) and the sudden drop of 16% during the period 2020-21 weighed on the GDP. Next, oil contributes almost a fifth of all indirect taxes (Center and States combined) and indirect taxes represent approximately 50% of all tax revenue.

It is an important dependency that explains the sharp drop in taxes (-24.9%). A third aspect is that oil imports, on average, account for about 85% of the trade deficit and the impact that deficits have on GDP, inflation and the external value of the rupee is well known.

Finally, the link between oil and inflation is indisputable. It was previously understated in core inflation calculations due to the structuring of the weights (fuels and lighting did not include petrol and diesel but fell under transport services).

But the fact that modified core inflation (introduced since June 2020, excluding all fuels) is lower than conventional core inflation shows the impact of fuel prices.

Chain effect

The energy intensity of the economy is not its only problem. The low-income trap (per capita income below $2,000) is itself the result of several structural deficiencies inherited from the past—the informal economy, low labor force participation, low literacy, and low productivity. Low income creates an impact chain.

It restricts the consumption and demand base necessary for growth, but above all the tax base, which is crucial to finance state intervention in the economy, necessitated in the first place by low incomes and strong inequalities.

This has led to a significantly high reliance on indirect taxes (49 percent), which is not only regressive but also unsustainable in the long run. This triggers another chain of effects that we have seen at work: lower consumption leading to lower taxes, higher borrowing and inflationary pressures.

Energy import intensity adds to the woes – persistent trade deficits necessitate higher levels of foreign exchange reserves, which are now increasingly dependent on capital flows (FDI, portfolio investment) than on trade and whose l he impact on inflation and exchange rates cannot be ignored.

The resumption of growth is akin to a restart of the economic machine after the power has been restored and cannot be interpreted as the start of a new growth story. The question is not about being the fastest growing economy, but about the pace that would propel it out of its low-income orbit and the problems that come with it.

The author is an independent financial consultant

Published on

June 19, 2022