Analysts are surprised that GDP has contracted by only 7.5% in real terms in the second quarter of 2020-21 while it had declined by 23.9% in the first quarter . This welcome news has raised hopes of a quicker economic revival if there is no second wave of COVID-19 in the winter months. Whether or not this comes about depends on how correctly the quarterly numbers reflect the state of the economy. Doubts on this score have been raised at several levels.
The Ministry of Finance, based on high frequency data, such as freight traffic, electricity consumption, GST collections and recovery of core sector production from the lows, has argued that the economy is rapidly recovering. The government’s press note announcing the Q2 GDP numbers also has a similar table. While all this is fine, there is less satisfactory news that is not contained in official pronouncements.
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Methodological issues
In the press release, points 9 and 10 suggest that the full extent of data usually used to project quarterly growth rates were not available and so “some other data sources” were used. It admits that “these were clearly limited” and states that estimates are “likely to undergo revisions”. This was also stated in the press note when the Q1 numbers were announced. It is not clear why in spite of the economy unlocking since June, the data are still limited or why alternative data had to be used.
Be that as it may, there are two implications of these statements. First, the data of Q1 and Q2 are not only not comparable with each other but also with the data for 2019-20. The shortcomings in the data cannot be rectified later since if the data were not available/ not collected, they cannot be obtained later. So, there cannot be certainty about the speed of economic recovery.
Second, the method of calculation of quarterly growth rates was already flawed. Are these flaws getting aggravated due to the lack of routine data? The biggest flaw is that almost no data from the unorganised sectors, except for agriculture, are available to calculate the contribution of this component of the economy to the GDP. It was implicit in the method of estimation that this component could be proxied by the data from the organised sectors of the economy. This was never a good assumption. After the shock to the economy due to the lockdown, this is even less valid. Demonetisation in 2016 had already disrupted this link between the organised and the unorganised sectors. Now the disjuncture is much greater.
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Impact of a shock on estimation
The non-agriculture unorganised sector was disproportionately impacted by demonetisation. This was a result of the fact that this sector consists of tiny units that work with cash. So the cash shortage impacted it far more than the organised sector which uses formal money markets, like banks, and can use digital transactions. So, the proportionality between the two sectors was disrupted. Further, small units with little capital exhaust it quickly if they are shut down even for a week. So, they find it difficult to restart.
The effect was that the unorganised sector declined while the organised sector recovered. The trend was further aggravated by the implementation of the flawed Goods and Services Tax (GST) which favoured the organised sector, and demand shifted from the unorganised sector to the organised sector. It was not that the unorganised sector became formalised; it just withered.
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The growth of the organised sector since demonetisation has been at the expense of the unorganised sector. The higher growth rate of the economy actually masks the decline in the unorganised sector. For instance, higher GST collections reflect the growth of the organised sectors. As former Finance Minister Arun Jaitley had famously said, 5% of the units pay 95% of the GST. Clearly, growth of the economy has been much less than that what is implied by the official GDP numbers.
The lockdown has aggravated this tendency of overestimation of GDP. A lockdown implies a voluntary shutdown of economic activity (but for production of essentials). It impacted both the organised and unorganised sectors of the economy. Most small and tiny units exhausted their working capital and are finding it difficult to revive. But this is not captured in official data which are based on limited organised sector data — the high frequency data quoted by the official agencies.
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In many instances, the organised sector is doing well at the expense of the unorganised sector. For instance, e-commerce has grown rapidly at the expense of brick-and-mortar stores since demand has shifted due to people’s fear of going out. So, while trade has declined, data will indicate growth since it is available only from e-commerce and big stores. In fact, the higher the growth shown in official data, the more it signals the collapse of small retail stores.
All sectors of the economy have an organised and an unorganised component. For instance, one can buy branded Parle biscuits or from a local bakery. In the textile sector there are the branded items and the ones produced in power looms and handlooms. The capacity utilisation in this sector is reported to be about 70% to 80%. While the larger units started operations, the smaller ones are languishing due to lack of working capital. So, if the data are taken only from the larger units, there would appear to be normalcy and the decline of 20% to 30% will not be captured.
Also read | Manufacturing, services lead recovery: SBI
Not all data are captured
As the lockdown was eased, more of the organised sector was able to restart business but not the unorganised sector. Many businesses in the organised sector too have not been able to recover to last year’s level, such as education, health, hotels, airlines, travel and tourism. This has a knock-on effect on all kinds of small producers. Further, employment is hit and that means demand in the economy also does not recover and especially for the produce of the unorganised sectors. Much of this is also not captured since the data used are from the large units and the corporate sector data from the stock markets. In brief, the quarterly growth numbers are not robust and now more so due to the shock of the lockdown. So, while the economy is recovering, it is difficult to say how quickly because of non-comparability. The impression being created of a return to normalcy masks the crisis persisting in the lives of large sections of the citizenry.
Arun Kumar is Malcolm Adiseshiah Chair Professor, Institute of Social Sciences, and author of In dian Economy’s Greatest Crisis: Impact of the Coronavirus and the Road Ahead
Published - December 10, 2020 12:15 am IST
