Economic Survey 2017 holds a mirror to Arun Jaitley on demonetisation impact

The big takeaway from the Economic Survey 2017, tabled in Parliament on Tuesday, is that it rightly acknowledges the short-term pain in the economy in the aftermath of the demonetisation announced by Prime Minister Narendra Modi on 8 November. At the same time, one must note that the survey aggressively defends the government’s move betting on its long term gains such as expected reduction in black money, improved tax collection and long term growth.

CEA Arvind Subramanian, who has authored the survey, has forecast an economic growth of 6.5 percent for the current fiscal year, a more pessimistic view compared with the CSO and RBI estimate of 7.1 percent but a number that largely agrees with International Monetary Fund (IMF) forecast of 6.6 percent.

It is interesting to note Subramanian’s specific comments on demonetisation and the ongoing digitisation drive of the Narendra Modi government.

The CEA warns that the cash crunch should be resolved as quickly as possible to ease the pain in the economy, the survey says. “The faster the remonetisation takes place, the shorter and less severe will be the impact of demonetization”. The survey also notes that growth rate of industrial sector will moderate to 5.2 percent this fiscal, from 7.4 percent last fiscal year.

Subramanian’s survey warns that note ban will adversely impact cash-intensive sectors such as agriculture, real estate and jewellery. “Recorded GDP will understate the impact on the informal sector because informal manufacturing is estimated using formal sector indicators,” the survey said.

“But over time as the economy becomes more formalised the underestimation will decline. Recorded GDP will also be overstated because the banking sector value added is based (inter alia) on deposits which have surged temporarily,” the survey adds.

On the digitisation, Subramanian pitches for the continuation of the move but says the change should be gradual rather than forcing on people. “Digitalisation is not a panacea, nor is cash all bad. Public policy must balance benefits and costs of both forms of payments. Second, the transition to digitalisation must be gradual, take full account of the digitally deprived, respect rather than dictate choice and be inclusive rather than controlled,” said the survey.

These comments are significant in the context of the Modi government’s demonetisation drive and the subsequent massive push towards the ‘cashless economy through incentives’. In this context, Jaitley’s challenges are multifold.

As the economic survey points out, he needs to first get the economy back on track by speeding up the remonetisation process and get normalcy back. Nearly three months into demonetisation, the cash crunch still continues. On Monday, the RBI announced some relaxations on cash withdrawals but it has not yet given a final word on till when the cash curbs will be withdrawn fully.

By now, it is a fact that the cash crunch has already hit the informal sector badly. Hit the consumption demand in the economy and resulted in job loss. According to a study by All India Manufacturers’ Organisation (AIMO), in the first 34 days since demonetisation, micro-small scale industries suffered 35 percent jobs losses and a 50 percent dip in revenue. The study showed nearly all industrial activities came to a standstill post note ban, with the Small and Medium-sized Enterprises (SMEs).

Subramanian’s economic growth projections and his caution on the impact of demonetisation is reminder to the government that why it is crucial to resolve the cash crunch fast. Secondly, the survey cautions on the need for reforms on taxation and financial sector reforms. It moots faster reduction in corporate taxes.

Besides, Jaitely also have a major task in offering a roadmap to address the problems in the banking sector that is critical to the economy. At least 7 of the PSU banks have their Tier-I capital adequacy less than 8.5 percent and one bank less than 8 percent. The problem is worsened with their non-performing assets (NPAs) hitting the roof (nearly Rs 6 lakh crore as on September, 2016 or nearly 8 percent of the total bank credit), and total chunk of stressed assets (bad loans and restructured loans together) jumping to 12-13 percent of the total bank credit.

Under the government’s Indradhanush plan, of the Rs 1.8 lakh crore capital needed by banks under Basel-III, the government has offered to infuse Rs 70,000 crore over four years till 2018-19 and wants the government banks to fend for themselves for the remaining Rs 1.1 lakh crore from the market. This is not enough. Also, it is almost impossible that weak state-run banks will find takers. This compounds the problem. So far, there is not much progress on the banking reform front.

By sharply revising the economic growth projection a few notches below for the current year and highlighting the short term pain in the economy, Subramanian is holding a mirror to finance Minister Arun Jaitley, who is set to present the Union Budget on Wednesday. As noted in an earlier column, this Budget will be the biggest test for Jaitley so far, since he has to prepare a blueprint to take the economy fighting the note ban impact and find the fiscal room to continue the growth momentum. All eyes on FM Jaitley tomorrow.