Economic activity in India slowed down in 2019-20 as a synchronised global downturn amplified by drags on aggregate demand took a costly toll. After remaining benign in the first half, headline inflation picked up subsequently on spikes in food price inflation. Monetary and credit conditions reflected deceleration in underlying activity in the economy. Financial markets turned volatile in the later part of the year in sync with global markets, reflecting the impact of the pandemic. Public finances recorded deviations from budgetary targets due to shortfalls in tax revenue and disinvestment collections. On the external front, the current account deficit narrowed with net capital flows remaining robust; foreign exchange reserves rose during the year. II.1 THE REAL ECONOMY II.1.1 Amidst a loss of momentum across geographies, escalation of trade tensions between China and the US, uncertainty over Brexit, and heightened geo-political risks, the global economy grew at its slowest pace in 2019 post global financial crisis. Just as these retarding forces appeared to be easing their grip towards the close of the year, the novel coronavirus (COVID-19) broke out and rapidly exploded into a pandemic, darkening global economic prospects and imparting extreme uncertainty about the outlook. II.1.2 As contagion was spreading to over 200 economies across the world, claiming over 59 lakh infections and 3,67,166 deaths worldwide by May 2020, the release of provisional estimates (PE) of national income by the National Statistical Office (NSO) at the end of the month revealed that the growth of India’s real gross domestic product (GDP) had slumped to 4.2 per cent in 2019-20 (6.1 per cent a year ago), the lowest since 2009-10. A downturn that set in during the last quarter of 2016-17, abstracting from ephemeral base effects in the second half of 2017-18, caused economic activity to lose speed over eight consecutive quarters to touch a low in Q4:2019-20 that has not been seen in the history of the 2011-12 base series. All components of domestic demand were driven down, except government final consumption expenditure (GFCE), which provided sustained support to aggregate demand. On the supply side, activity in manufacturing, construction and transportation was pulled down by sector-specific impediments1. Agriculture and allied activities provided a silver lining, on the back of record foodgrains and horticulture production, coupled with resilient allied activities and an outlook brightened by expectations of a normal south west monsoon (SWM) in 2020. II.1.3 Against this backdrop, this chapeau is followed by component-wise analysis of aggregate demand. Developments in aggregate supply conditions are analysed in sub-section 3. The last sub-section covers analysis of employment based on high frequency indicators and includes an assessment of the impact of the COVID-19 pandemic and major policy responses. Policy perspectives are set out in the concluding paragraph. 2. Unravelling the Demand Slowdown II.1.4 The May 2020 release of PE for 2019-20 offered a first glimpse at how the economy fared in Q4:2019-20 and, therefore, in the year as a whole; it also brought to bear revisions to estimates for the preceding quarters. The new release confirmed a 2.8 percentage points reduction in the growth of aggregate demand below its decennial trend rate of 7.0 per cent, and a sequential deceleration from a recent peak of 7.9 per cent in H2:2017-18. Real GDP growth in H2:2019-20 at 3.6 per cent was also the lowest registered in the 2011-12 base series (Appendix Table 1). The disruption caused by the imposed lockdown brought economic activity to a near standstill during the last week of Q4:2019-20 (Table II.1.1). II.1.5 The three-quarter moving average of seasonally adjusted annualised growth rates (MA-SAAR) corroborated the weakening of the momentum of demand (Chart II.1.1). Consequently, the negative output gap (i.e., deviation of actual output from its potential level) widened in 2019-20, pointing to the substantial slack in resource utilisation. Consumption II.1.7 Private final consumption expenditure (PFCE), constituting 57.2 per cent of aggregate demand, recorded its lowest growth in a decade. Nonetheless, at 5.3 per cent in 2019-20, PFCE growth exhibited resilience in the face of the prolonged weakening of income and financial conditions. High frequency indicators of consumption demand either contracted or grew at a rate far below their long-run averages. Petroleum consumption remained flat, while non-oil non-gold imports remained in contraction all through the year. Among indicators of urban demand, passenger car sales contracted throughout 2019-20, exacerbated by idiosyncratic factors such as rising insurance costs and tighter emission norms. Other indicators of urban demand, viz., consumer durables and air passenger traffic also remained depressed during the year, with the latter bearing the brunt of an exogenous shock due to the grounding of a major airline.
terms of trade for the farm sector revived demand and catalysed a spurt in tractor sales between December 2019 and February 2020 and stayed robust even during the pandemic period. Motorcycle sales, however, have remained in the contraction zone starting from January 2019. The weakness in rural demand was also aggravated by moderation in rural wages and dwindling employment avenues, and the slowdown in alternative sources of livelihood such as manufacturing and construction. GFCE compensated for the slowdown in private consumption, registering double-digit growth for the third consecutive year in 2019-20. Excluding GFCE growth of 11.8 per cent, GDP growth for 2019-20 would have decelerated by 0.9 percentage points from the headline GDP growth estimated by the NSO. The COVID-19 pandemic delivered an unprecedented shock to the economy. It remains to be seen whether the recovery from the pandemic will be V-shaped or U-shaped (Box II.1.1). Investment and Saving II.1.9 The rate of gross domestic investment in the Indian economy, measured by the ratio of gross capital formation (GCF) to GDP at current prices, had declined to 32.2 per cent in 2018-19. Although data on GCF are not yet available for 2019-20, underlying indicators point to investment having weakened further. The ratio of real gross fixed capital formation (GFCF) to GDP declined to 29.8 per cent in 2019-20 from 31.9 per cent in 2018-19 on account of waning business confidence. The corporate tax regime reform of September 2019 has not yet gained traction in boosting capital expenditure. Box II.1.1
Macroeconomic Impact of COVID-19 COVID-19’s epidemiological dynamics are still rapidly evolving in India, rendering difficult an accurate assessment of its full macroeconomic effects. In this scenario, an approach employing a dynamic stochastic general equilibrium (DSGE) model built on New Keynesian foundations provides a tentative and proximate assessment of the likely impact of COVID-19 and the subsequent lockdown on the Indian economy. The model has three main economic agents, viz., households, firms and the government. COVID-19 and the lockdown can impact the economy through multiple channels (Eichenbaum et al., 2020; Faria-e-Castro, 2020; Yang et al., 2020). Because of lockdown, households have to stay at home and therefore, reduce labour supply to firms; consumption falls due to non-availability of non-essential items and fall in income; and restricted people-to-people contact stalls the momentum of the pandemic. The model is calibrated2 so that infections peak around the second half of August 2020 [based on the predictions of a generalised Susceptible-Exposed-Infectious-Recovered (SEIR) model for India] and the output gap widens to about (-) 12 per cent of potential output when the economy is worst hit. Two scenarios are envisaged: the first, i.e., lockdown I, impacts the supply side of the economy by decreasing the labour supply and its productivity. The second scenario, i.e., lockdown II, additionally considers the increase in marginal cost. Inflation falls under both scenarios mainly because of a fall in demand; under lockdown II, however, the decline in inflation is less steep and short-lived. Firms respond to the squeeze in profits, due to higher marginal costs, by curtailing production and labour demand. Wages see a lower rise and economy goes through a large contraction. However, the recovery from the pandemic is faster in this scenario on account of fewer opportunities for people-to-people interactions. Under scenario I by contrast, production retrenchment is less severe, but demand contraction is more pronounced due to a rise in infections. Thus, the economy undergoes a deeper contraction under lockdown II, but recovery from the pandemic is faster (Chart 1).
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