Co-presented by

GDP decline: Narendra Modi was wrong in saying demonetisation was performed on a healthy body, it wasn’t

On the growth front, India’s economy is facing a crisis situation. There is no denying of this fact even in the Bharatiya Janata Party (BJP) camp, evident from the talk points listed in a top party meet today. Did demonetisation and goods and services tax (GST) alone cause this? Certainly not; the economy was already slowing down for some five quarters. What Prime Minister Narendra Modi’s two big ticket economic moves, particularly, demonetisation of Rs 500, Rs 1,000 notes did was to accelerate the slowing process by releasing temporary (but significant) shocks in multiple layers into the economy. It was more than what a weak economy could withstand. The government has finally acknowledged it, hence the talks of an economic stimulus.

Let’s look at numbers. Right now, the growth scenario looks far from promising for an ambitious economy. The warning signals are all around. India’s gross domestic product (GDP) grew at 5.7 percent in June quarter, the slowest pace in more than three years and the index of industrial production (IIP) grew at a dismal 1.2 percent in July compared with 4.5 percent a year ago. Bank credit growth is showing no signs of a pick-up. In July, non-food bank credit growth of schedule commercials banks slowed to 5.3 percent as compared with a rise of 8.3 percent in the same month last year.

Credit growth to industries hasn’t shown any improvement for a while. While top-rated companies have moved to the money market, small firms are facing a severe fund drought, which in turn, impacts production and employment generation. On the other hand, inflation is inching up. The consumer price index-based inflation jumped to a five-month high of 3.36 percent in August from 2.36 percent in July. This means, the room for the monetary policy committee (MPC) to offer further rate cut boost to the economy is limited.

What can the government do to come out of this situation? First, of course it can loosen up the purse strings more. Modi can easily forget the government’s fiscal deficit roadmap (3.2 percent for FY18) and ask his finance minister Arun Jaitley to ramp up infrastructure spending. Apparently, there is already a plan in the offing, under which the government plans to infuse Rs 50,000 crore to boost infrastructure spending in the backdrop of absence of private investments. If executed, it can cause the fiscal deficit target to overshoot the budgeted figure and rise to around 3.7 percent. The problem is that even such a stimulus won’t work beyond the short-term in the economy since the reasons for the current slowdown are far deeper.

 GDP decline: Narendra Modi was wrong in saying demonetisation was performed on a healthy body, it wasn’t

Prime Minister Narendra Modi. Reuters

These are more structural in nature, requiring bold reforms and long-term planning. The main among them is the sad state of the banking sector, where total gross non-performing assets (NPAs) have risen to Rs 8.29 lakh crore in June 2017. The actual amount of stressed assets would be far higher if one takes into account the restructured loans that can turn into NPAs if things don't go as expected. Public sector banks (PSBs) contribute over 90 percent of this chunk. The government owns above 75 percent stake in at least ten out of the 27 public sector banks. It hasn’t acted enough to resolve the capital shortage in these banks or privatize them to let private capital come in.

As discussed in an earlier article, the government has, so far, failed to offer a concrete plan to solve the capital woes of public sector banks. The ‘Indradhanush’ plan envisaged the government infusing Rs 70,000 crore in PSBs over a period of four years. But, this was too little. The government then asked banks to fend for themselves for the remaining money, i.e., by raising funds from the market. But, this plan didn’t work well since there were hardly any takers in the market to invest in these weak banks.

Till date, the government hasn’t come up with an alternative plan to find an answer to the capital dilemma of banks. A weak banking system, out of which government owns 70 percent of banks in terms of their assets, doesn’t augur well for the economy. Right now, on account of huge NPAs and poor demand, banks are unable to lend in a big way to productive sectors. This is a major hurdle for growth recovery. Secondly, the government needs to work on land and labour reforms that are politically sensitive, hence put in the back-burner by successive governments. On account of the difficulty across states to acquire land and labour, large companies still think twice before planning their India ventures. In fact, making land available to industries, especially foreigners who want to set up factories in India, is key to Modi’s Make in India program. But, this continues to be a problem even after three years of this government’s rule.

Another weak area is lack of new jobs. This has emerged as a major headache for the Modi-government. Speaking at his book launch recently, former RBI governor, Raghuram Rajan flagged this problem (read a report here). "Remember that we have what we call the population dividend. A million new people entering the labor force every month," Rajan said. "If we don’t provide these jobs that are required, you have a million dissatisfied entrants. And that could create a lot of social mischief," Rajan said.

Acknowledging the problem

While the solutions are well-known, it is important to acknowledge the problems first. This government and its cheerleaders have been largely reluctant to do that. By now, it is more than clear that the Indian economy was not in good health when demonetisation was launched in November last year, contrary to what Modi and Jaitley claimed.

“Since the economy was in strong condition, the timing of demonetisation was the best," Modi had said in Lok Sabha during his reply to the motion of thanks on President Pranab Mukherjee's address (read a report here). "When can you have an operation? When the body is healthy. The economy was doing well and thus our decision was taken at the right time," Modi had said. Jaitley too painted a rosy picture of the economy during the post-demonetisation days.

It takes a few quarters before an economic trend sustains. It is quite evident now that economy was not in good health at the point when 86 percent of the currency in circulation was withdrawn in November last year and things have only worsened since then. After three quarters post the note ban, all macro-economic indicators tell us that a slowdown is a reality now. The government should have preserved the strengths of the economy to navigate it to a steady course, instead of shocking it with a massively disruptive move. The demonetisation operation was performed on a body that lacked even minimum health. The results are what we see now. Modi’s big challenge now is to acknowledge the mistakes, the current sad state of the economy and handhold it to recover the lost momentum.

Your guide to the latest election news, analysis, commentary, live updates and schedule for Lok Sabha Elections 2019 on firstpost.com/elections. Follow us on Twitter and Instagram or like our Facebook page for updates from all 543 constituencies for the upcoming general elections.

Updated Date: Sep 25, 2017 12:43:49 IST