The surprise resilience shown by the manufacturing sector that restricted GDP contraction to only 7.5 per cent in September quarter could be a result of massive purge in costs such as employee cost by corporates and businesses, which could turn a potential headwind in future, economists at SBI wrote on Saturday.
India's July-September (Q2 of 2020-21 fiscal) GDP growth showed surprising resilience with contraction of only 7.5 per cent in real terms, while the market consensus was higher, wrote Soumya Kanti Ghosh, group chief economic adviser, State Bank of India, in Ecowrap.
With improvement in manufacturing, due to lifting of lockdown measures, GDP contraction has slowed down significantly. Agriculture sector continued to perform well with growth at 3.4 per cent. Services remained in the negative territory, although the decline was contained as trade, hotels, transport, communication and services related to broadcasting showed recovery.
"The most astonishing number is the positive growth in manufacturing Q2. Despite being the worst affected sector in Q1(due to lockdown), it is quite puzzling how manufacturing turned itself around," he wrote in the Ecowrap issue.
The IIP manufacturing and manufacturing GVA growth are highly correlated (almost more than 0.90) and this correlation collapsed in Q2 when IIP manufacturing declined by 6.7 per cent (average of July-September) while manufacturing GVA grew by 0.6 per cent.
"We believe one possible reason for this could be stellar corporate GVA numbers in Q2 on the back of massive purge in costs. Further, we observed small companies, with turnover of up to Rs 500 crore, are more aggressive in cutting cost, displaying reduction in employee cost by 10-12 per cent," Ecowrap said.
This, it said, could turn a potential headwind in future in terms of a drag on consumption. "Additionally, there is evidence of inventory buildup that could act as a drag on future manufacturing growth."
Interestingly, government consumption expenditure has also nosedived in Q2, that is difficult to explain, as such expenditures are typically pro cyclical, Ecowrap said.
SBI economist said the absolute numbers of services sector in Q2FY21 is Rs 17.19 lakh crore, while in Q3FY20 it was Rs 17.35 lakh crore, only Rs 15,000 crore less. This indicates that the services sector has reached the pre-COVID-19 level.
"Is it because of behavioural changes during pandemic like massive transport of goods once the economy opened up and a massive boost to communication and broadcasting with people mostly working from home?" it asked.
One good thing is that the investment demand has improved with resumption in COVID-19- induced stalled projects. However, the patchy growth across sectors reflects in domestic demand figures, which are showing modest recovery sequentially.
The falling imports and continued contraction in investment suggest a poor domestic absorption and intermediate demand.
"The reading of Q2 GDP suggests that the output gap has not corrected to the point that it will be a concern for demand pull inflation. Further, the inflationary pressure in agriculture goods despite expanding output has further capped policy option.
"The policy option must move towards continued easing mobility of goods and give massive thrust to the construction and infrastructure sector. More focus should be on increasing the ease of doing business and private sector participation," it said.
The economist said the recent measures that the government has taken are in the right direction and should be pursued to further spur the economic momentum.
Economic momentum as given by the business activity index shows steady improvement in the latest week after a temporary blip witnessed during the Diwali week owing to holidays. The SBI Business Activity index has jumped to the highest level since March 9.