Since my column ‘Growth or No Growth: Paradoxes of Chaotic and Complex Systems
’ appeared in Moneylife
, a lot of information on the state of the economy has come into the public domain. The Central Statistical Organisation (CSO) indicated a gross domestic product (GDP) growth for FY20-21 at -7.7%. The Economic Survey 2020-21, that followed, pegged growth in a similar range. But the Economic Survey fell critically short of expectations, given the extraordinary background it was written against. The Survey failed to communicate the true extent of the damage and the possible strategy that should have been adopted.
As discussed earlier, a systems understanding of the impact of the COVID-19 pandemic lock-down is still to begin in earnest. As a tribute to the discipline of systems thinking, and to take the debate started by Debashis Basu to its logical conclusion, this write-up presents a systems view of the impact of the COVID-19 lock-down on the Indian economy.
Drawing from the disaster management literature and employing the technique of Leontief input output (IO) analysis, the systemwide impact of closure of transport and hotels is considered. The method employed here is superior to the one used by the Economic Survey Vol 2 (pg 10-11) which is an adaptation of a study done by Xavier Estupinan and others at the Indira Gandhi Institute of Development Research (IGIDR
). Authors estimate the first order supply shock through labour supply reduction associated with the containment measures taken by the government. But researchers accept in their original paper that “in the medium run, the actual losses could be higher as the output will subsequently be affected by second order supply shocks and demand shocks.”
The advantage of the IO method precisely is that it is capable of estimating the higher order impact of COVID-19 lock-down. The Economic Survey mentions (para 1.15, Vol 2) that “first order supply side disruptions potentially created second round effects on both demand and supply,” but made no efforts to quantify those losses. It is well known in disaster management literature that both rank ordering of losses and sectoral linkages assume importance in designing a policy response. Decision making for recovery is sequential rather than simultaneous.
Thus Economic Survey’s claim of drawing inspiration for economic management from the Spanish Flu of 1918-1919, the worst influenza pandemic in history which killed an estimated 50 million people, is somewhat unconvincing. A vital intelligence driven input on the propagation of the pandemic shock was missing in their analysis, which now reflects in unimpressive allocation of funds and confusion in determining sectoral priority in the Union Budget 2021-22.
Now, the lock-down created a simultaneous demand-supply shock (or output inoperability shock) which in turn created a subsequent round of demand shock in all the other sectors via the inter sectoral linkages. Since the linkages between different sectors and geographies is not uniform, the impact of the lock-down is also not uniform. All these complex dimensions can be captured in one single table for 26 sectors.
Results generated in June 2020 have been preserved in the original form for back testing in February. Surprisingly, the method turned out to be robust. The GDP growth for FY20-21 is estimated at -6% which is very close to the official advance estimate. Since the loss of demand in foreign markets has not been accounted for, the unorganised sector is not represented adequately, the -7.7% estimate may, in fact, be revised upwards in future. What has been missed out is that COVID-19 lock-down resulted in gross output loss of 7% which entails that the system will operate at a lower capacity utilisation or permanent loss of output (that is bankruptcy) with a higher natural rate of unemployment.
It is obvious that the transport and hotels sectors took the biggest brunt of the losses. But agriculture also lost Rs1.5 lakh crore, an observation at odds with a largely positive picture painted. This is because a part of the output of agriculture is absorbed in hotels, tourism and air transport. The budget has virtually nothing for the tourism or hotel sector; thus full potential of the agricultural reforms may take time to accrue. Persistent rise in domestic fuel prices has affected the solvency of the transport sector and has created a second round of inflation over and above the supply chain disruption created by the pandemic.
Emphasis on the financial sector as the nodal sector in the AtmaNirbahar package does not find backing in this analysis. The financial sector will itself suffer a demand loss of 3.5% owing to the shock. Furthermore, the sector has a high forward linkage and low backward linkage, implying it is dependent on demand from other sectors. Thus despite higher sanction limits (supply of credit), the credit offtake has been lacklustre.
The distribution of losses is equal between labour and capital. The total loss is Rs10.6 lakh crore. Since mixed income of the self-employed is the largest component in value added, a back of envelop calculation suggests that approximately seven crore individuals were directly affected by the pandemic (Rs 10.6 lakh crore/ per capita income @ Rs1.51 lakh). The losses in urban centres is higher than in rural areas largely because the closure of air transport affected the urban local economy severely while restrictions on interstate and intra-state road mobility affected the rural areas.
One can dig more but to conclude, a few observations are made. First, will there be a V-shaped recovery? Accounting for the loss of productivity and contraction in the investment rate in FY20-21, the potential output growth that can be achieved is close to 5.8-6%. This is a full 100 bps lower than the RBI estimate of around 7%. The double-digit forecast is largely on account of a lower base. Second, the fiscal math in the budget has created a situation for stagflation (which others have also observed) which will push another cohort of the population at margins below the poverty line, deepening the demand loss, further making Sanjaya Baru’s k-shaped recovery more appealing.
Third, the present economic challenges are not just the product of COVID-19. It began with FY14-15 & FY15-16 which was two successive years of droughts, a rare natural disaster in the past 115 year. This was followed by demonetisation and GST (goods and services tax), well thought out choices but poorly executed. Thus, by the time COVID-19 outbreak happened in Q3 FY19-20, the economy was already operating at 300bps below the potential output of 7%. The Budget has not addressed the fall outs of any of the previous events.
To end on a sombre note, unless the macro policy is reconfigured, the first quinquennial of the 2021-30 decade is at a risk of full opportunity lost.
(The author is an economist in the banking system. The views are personal)