Is India’s ‘economic recovery’ a mere illusion?

Illusions arise when the mind confuses the apparent with reality. Statistical illusions are no different. When the National Statistical Office (NSO) released the latest estimates of national income on May 31, indicating that the Indian economy grew at 8.7 per cent in 2021-22, those favourably disposed to the Narendra Modi government immediately asserted that the economy was in recovery mode, two years after the pandemic had upended it.

The growth in gross domestic product (GDP) by 4.1 per cent in the last quarter of 2021-22, compared with 2.5 per cent in the same quarter the previous year, was also cited as proof of an economy in recovery mode. Lost in the euphoria was a simple point: the basis for the optimism rests on an illusion—referred to as the base effect problem in statistics—which arises from the careless use of percentages, especially in a period of volatility.

Statistical illusions

This can be explained with a simple example. A slippage of 50 per cent from a growth rate of, say, 10 per cent would imply 5 per cent, but a recovery of a similar magnitude would only imply 7.5 per cent. In effect, the “recovery” would still leave the growth of national output, which is what GDP is, 25 per cent short of its original growth trajectory. To be sure, an annual rate of growth of 8.7 per cent in GDP would place India among the fastest growing economies in the world. But this is a selective positioning of facts: after all, the Indian economy was one of the worst performers globally in the immediate aftermath of the pandemic.

A simple way of avoiding this confusion would be to ignore percentages and examine actual levels of output before and after the collapse. This would provide a true assessment of how much the economy has “recovered”. Taking this approach further, it is possible to evaluate economic performance in the Narendra Modi years, from 2014 when his government first assumed office.

In the accompanying graph, these eight years are divided into two halves: the first between 2014-15 and 2017-18 and the second between 2018-19 and 2021-22.

In the first half, the economy grew at an annual average rate of 7.63 per cent. In the second half, the average annual growth rate of GDP was less than half of this: 3.01 per cent. To those who argue that the latter average was significantly affected by the pandemic, it must be pointed out that even if 2021-22 is removed from consideration, the average growth rate works out to only 6.3 per cent, about 17 per cent lower than the first half of the Modi years.

Now let us turn to the levels of output. According to latest estimates, the GDP, measured in constant prices (base year 2011-12 prices), is provisionally Rs.147.36 lakh crore. Instead of comparing this level of output to the previous year, which is what a careless use of percentages would normally entail, let us compare this to the level of output in 2019-20. This reveals that the economy has been running to stay in the same place in the last two years. The level of national output expanded by just 1.51 per cent over a two-year period—an average rate of just 0.75 per cent. Calling that a recovery would be a cruel joke.

This miserable rate of expansion in national output is captured in another data set released by the NSO. Looking at national output in per capita terms has the advantage of providing an estimate of how much output has grown relative to population. The results are striking.

Per capita GDP, per capita gross national income and per capita net national income were all lower in 2021-22 than in 2019-20. What this indicates is that each Indian now has less than what they had two years ago.

Sectoral laggards

Let us now examine the claims of a recovery by looking at various sectors. This would help identify sectors that are relatively more dynamic and those that are laggards. NSO statistics provide two basic sets of data pertaining to national accounts: gross value added (GVA) and GDP. The difference is that GDP is inclusive of taxes, while GVA measures the net value addition in the economy.

In the NSO’s scheme of presentation, GVA is provided for different sectors of the economy, while GDP is disaggregated in terms of the expenditure components. Thus, the two taken together provide two different snapshots of the economy.

Although GVA appears to have increased impressively, by 8.1 per cent in 2021-22, when compared with the previous year, it is again a statistical illusion. It shows that GVA in 2021-22 at Rs.136 lakh crore was just 2.92 per cent higher than in 2019-20, an average annual increase of less than 1.5 per cent.

Despite all the talk about ‘Make in India’ and ‘Aatmanirbhar Bharat’, the manufacturing sector, which has the potential to generate economy-wide spinoffs in terms of output and employment, has languished in the last few years. | Photo Credit: VELANKANNI RAJ B

In fact, overall GVA increased by a measly 3.26 per cent in the second half of the eight years of Modi’s rule, compared with the first four years when it increased at an annual average rate of almost 6 per cent. This supports critics’ claims that the economy has decelerated significantly in the last few years. Importantly, the deceleration predates the pandemic.

In 2021-22, GVA in manufacturing, which accounts for about 18 per cent of overall GVA, was Rs.24.71 lakh crore. This was just 5.69 per cent higher than 2018-19, which translates to an annual average growth rate of less than 2 per cent. Despite all the talk about ‘Make in India’ and ‘Aatmanirbhar Bharat’, this sector, which has the potential to generate economy-wide spinoffs in terms of output and employment, has languished in the last few years.

GVA for trade, hotels, communication, and services relating to broadcasting, all of which constitute a sector that is a major source of jobs albeit informal and with low wages, has suffered a massive setback. This sector’s GVA declined by 6.03 per cent between 2018-19 and 2021-22. In fact, this sector’s GVA in 2021-22 was just 0.76 per cent higher than in 2017-18.

In construction, a sector that has been relatively dynamic in the last decade, GVA grew at 4.68 per cent between 2018-19 and 2021-22—an annual increase of just 1.56 per cent. Thus, GVA in these three vital sectors, which account for more than two-fifths of the overall economy and which are a significant source of employment, has decelerated significantly in the last three years.

Real estate has been one of the few sectors which has shown signs of optimism. | Photo Credit: RAGU R

The only signs of optimism come from finance and real estate, public administration, and defence. GVA in the finance and real estate sector has grown by almost 14 per cent since 2018-19, but this possibly mirrors the runaway boom in prices of financial assets, particularly in the stock markets. It is also striking that this sector has grown despite the sharp deceleration in construction activity, indicating that speculative excess rather than productive investment is in play. The fact that this sector accounts for more than a quarter of all economic activity indicates how one sector can skew perceptions of the whole economy.

Demand compression

National GDP, when sliced in terms of expenditure components, provides another view of economic performance. The two main expenditure components—private final consumption expenditure (PFCE) and gross fixed capital formation (GFCF), account for almost 90 per cent of overall national GDP.

While PFCE is a good proxy for overall consumption, or the level of demand in the economy, GFCF reflects the level of investment associated with the creation of capital assets. These two components thus provide a fairly comprehensive view of how investment and consumption have fared in the Modi years.

The level of PFCE in 2021-22 was 1.44 per cent above 2019-20, an annual increase of about 0.7 per cent. In fact, between 2018-19 and 2021-22, PFCE increased by only 6.73 per cent—an annual average rate of just 2.24 per cent. It is obvious that the excessive reliance on monetary policy, particularly since the pandemic, has played a key role in arresting demand impulses in the economy. It is striking that in the first four years of the Modi years, PFCE increased at the rate of 7.18 per cent, while it grew at just 3.55 per cent in the second half.

Capital formation

While the demand contraction is obvious and reflected widely in the anecdotal reports of falling employment, declining wages, and stagnant output, capital formation, which has a bearing on the economy’s capacity for growth, has been slackening too.

Recent commentary has focussed on the fact that GFCF increased by about 15 per cent in 2021-22. This is purely a statistical illusion. In reality, GFCF in 2021-22 was just 3.75 per cent higher than two years earlier. Just as consumption has slackened, investment too has slowed down significantly, and this has little to do with the pandemic. In the first four years of the Modi rule so far, GFCF grew at an annual rate of 6.35 per cent and has since slowed down considerably to just 4.54 per cent.

The Narendra Modi government appears to have painted itself into a corner by focussing excessively on monetary policy. | Photo Credit: PTI

The Modi government appears to have painted itself into a corner by focussing excessively on monetary policy. Two rate hikes in quick succession, including an increase of 0.50 per cent announced on June 8, mean that base interest rates are now higher by 0.90 per cent than a few weeks ago, with more rate hikes on the horizon as the threat of inflation remains unabated. This has adverse consequences for not just investment but also consumption and, therefore, growth.

Moreover, this is likely to have a differential impact on businesses, with the smaller ones bearing a bigger burden than the conglomerates.

Widening output gap

Now, to evaluate the economy’s performance during the Modi years. Since we know that growth has slowed significantly in the second half, we can estimate the “gap” between what would have been achieved if the economy had maintained the momentum of the first four years and what has actually been achieved. Remember that GDP grew at an average rate of 7.6 per cent in the first four years, and then dropped to 3.1 per cent in the next four years.

If the economy had maintained the initial momentum of 7.6 per cent a year, the GDP ought to have been about Rs.176 lakh crore in 2021-22. Instead, actual output was Rs.28 lakh crore lower. The analysis (figure 1) makes it clear that a large fraction of national output has been irretrievably “lost” in the second half of the period. Indeed, the cumulative “lost” output in the second half amounted to Rs.63.8 lakh crore. To put this in perspective, it is as if a little more than 43 per cent of India’s GDP in 2021-22 was wiped out.

The growing uncertainty caused by a mix of high inflation, high levels of unemployment, stagnant consumption, and volatile exchange rates has effectively vitiated the investment climate. In such a situation, it would take a brave soul to insist that the economy is in recovery mode. The same hubris that characterised Prime Minister Modi’s premature declaration of victory over the pandemic last year is at play now in the declaration that an economic recovery is under way.

As Pete Seeger asked in one of his concerts many years ago: “Oh, when will they ever learn?”