GDP at 5.7%: Narendra Modi’s note ban hits economy hard; Manmohan Singh has the last laugh in growth debate

In late November 2016, when former Prime Minister Mamohan Singh called demonetisation a ‘ mammoth tragedy’ and warned about a 2 percent hit on GDP in the aftermath of the demonetisation, the Narendra Modi government and demonetisation cheerleaders rubbished Singh’s speech, a renowned economist and also a former Reserve Bank of India (RBI) governor. They refused to take note of the warning seriously, instead called it purely a political speech that lacks substance. Even some of the prominent economists with reputed research houses, laughed at Singh saying his was largely a guess work, not backed by data. After 10 months of demonetisation, with no major tangible gains from the exercise and severe hit on the economy, Singh has the last laugh on the debate. [caption id=“attachment_3996751” align=“alignleft” width=“380”]  Reuters[/caption] India’s gross domestic product (GDP) grew 5.7 percent, the slowest pace in more than three years, lower than the 6.1 percent and 220 basis points (one bps is one hundredth of a percentage point) less than 7.9 percent reported in the year-ago quarter. The prolonged impact of demonetisation, when 86 percent of currency in circulation was withdrawn overnight without a clearly drawn out plan of execution, has played a major role in the GDP slide. The impact of de-stocking by companies in the process of Goods and Services Tax (GST) rollout, added to the pain. This invalidates the remaining excuses of the government that demonetisation didn’t hurt growth. Remember, the Narendra Modi government went on a celebratory mode after the release of October-December quarter GDP numbers (7 percent) mocking the note ban critics. That time the then economic affairs secretary Shaktikanta Das had ruled out impact of demonetisation on GDP , “The third quarter GDP numbers are out and as you have seen the numbers completely negate the kind of negative projections and speculations made about the impact of demonetisation," Das said, adding, “An overestimation was done about the so called negative impact of demonetisation. It is very satisfying to know that it is not there. Because we still remain 7 percent plus growth country.” Das was proved wrong when the March quarter GDP came at 6.1 percent and yet again now, when the June quarter came at even lower at 5.7 percent. The 5.7 percent figure has come as a shocker to most economists who were forecasting the June quarter GDP on the upside of 6.5 percent. Surprised by the first-quarter GDP figure, most economists have scaled down their full-year projections to closer to 7 percent with a downward bias, from 7.6 percent to 7.8 percent predicted earlier. In a panel discussion on CNBC-TV18, Pronab Sen, former chairman of the National Statistical Commission, said he expects the full-year growth to be even lower at 6.3 percent.

GDP growth trend (YoY in %)
Infogram

The big drag on the GDP figure is clearly a sharp decline in the manufacturing segment, which grew just 1.2 percent in the June quarter compared with 10.7 percent in the year-ago quarter and 5.3 percent in the preceding quarter. Such a drop in the manufacturing activity, at multi-year lows now, doesn’t augur well for an economy that aspires to displace China and become the manufacturing hub of the world. Besides this, sharp drop was seen in agriculture (2.3 percent compared with 5.2 percent in the year-ago quarter) and mining (contracted by 0.7 percent from 6.4 percent sequentially) while trade, transport etc, finance and real estate, and public administration helped. But, the bigger shock is the major drop in the gross fixed capital formation (GFCF) numbers that indicate the investment activity on the ground. This fell to just 1.6 percent from 5 percent in the year-ago period, although showing a minor improvement sequentially. This is a major area of concern for the economy since investment activity is critical to reboot the economy to a higher a growth trajectory. Both the private and government consumption are yet to take off in a major way. But, the good part is that GDP numbers have finally started reflecting the real situation on the ground and the painful divergence with headline GDP numbers and a range of macroeconomic data is over. Demonetisation impact has finally become visible on the numbers. Certainly, this is good news from the perspective of quality data since it attaches more credibility to the official numbers, which is critical for the watchers of the Indian economy. The apparent divergent trend between high frequency economic indicators and headline GDP numbers has been perplexing the economists for a while. At a time when the private investment activity is yet to turn the corner, the government will have no options but to scale up public spending in a big way. But, the problem here is that it is in a tight spot with obligation to meet the fiscal deficit road map. It will have to either loosen the purse strings forgetting the FRBM roadmap or find ways to bring in large private investments. The other option for the government is to force the Monetary Policy Committee to go for more rate cuts. But at a time when the system is already in a surplus mode and the RBI is heavily conducting reverse repo operations to suck out excess cash, there isn’t much another rate cut can do to push lending. Also, banks are saddled with huge bundles of bad loans that acts as a major barrier for them to go for large-scale lending. There isn’t an easy way out. Of course, the impact of demonetisation will fade as time progresses but it will take a lot of time for the informal sector and small businesses to come out of the shock. It’s time the Modi government woke up to the real economic situation and begins work to repair the economy to get the lost growth momentum back. (Data contributed by Kishor Kadam)