The reactions after the economic growth data for 2016-17 released on 31 May showed that demonetisation has hit the economy hard have been predictable. Well almost.
The demonetisation disbelievers are predictably strutting about saying, we told you so (so, will they now stop the silly government-is-fudging-GDP-data line?). But the demonetisation believers, who had jeered at the former when the third quarter data released in February had shown minimal impact and were confident that the fourth quarter would also see token impact, have changed their tune somewhat. Now they say, oh but the government was always saying there would be impact for a couple of quarters.
There is much rejoicing among the disbelievers and Prime Minister Narendra Modi’s many critics that the data confirms the demonetisation-induced slowdown. This, they argue, is conclusive proof of colossal mismanagement of the economy by the Narendra Modi government.
How fair is that criticism? First let’s accept that demonetisation did result in the 0.9 percent drop in GDP growth in 2016-17 over 2015-16. And that it will cost India the status of fastest growing economy. But how much did the economy grow in 2015-16? Eight percent. When was the last time we saw that growth figure?
And what was the growth rate that this government inherited? In 2013-14, economic growth was 6.4 per cent. The Modi government came to power in May 2014, two months into the 2014-15 fiscal year. That year, the economy grew 7.5 percent.
The fudged data brigade will say this growth is the result of, well, fudging because the government changed the methodology and base year. Well, the same base year and methodology pushed up growth rates of the 2012-13 and 2013-14 as well. If post-2014 growth figures are fudged, then let’s go back to the sub-5 percent growth for two years performance of the UPA as well. And if the UPA-period post-revision figures are to be accepted, then the better performance of the economy under the Modi government (pre-demonetisation) also has to be accepted. That the economy was taken from 6.4 percent to 8 percent in three years is no mean achievement – a mis-step called demonetisation notwithstanding – and the government has got a fair amount of things right.
(All the data, even for the UPA years, are based on revisions using the new index of industrial production and wholesale price index. The difference between the old and new data is negligible.)
But that does not imply that the government does not have a problem on its hands. The quarter on quarter data show that the economy had started slowing even before demonetisation, though the slippage was sharper after that. In the first quarter (Q1) GDP growth was 7.9 percent, falling to 7.5 percent in Q2, 6.9 percent in Q3 and 6.1 percent in Q4. The GVA growth figures also show a similar picture – it has been steadily declining from Q4 of 2015-16 and the 5.6 percent growth is the lowest in seven quarters (data on earlier quarters based on the new IIP and WPI are not available just yet). This is something the government’s economic managers should watch closely.
Right now the economy seems to be coasting on the back of government spending, which grew 10.3 percent in Q3 and 17 percent in Q4 and private consumption, which has been growing upwards of 7 percent, with a sharp spike of 11 percent in Q3 of 2016-17. This alone will not take the economy back to 8 percent growth. There is only one pep pill the economy needs – investment. And that continues to play elusive.
What should seriously worry the government’s economic managers is the fact that gross fixed capital formation (an indicator of the investment rate) has dropped to 27.1 percent of GDP. In 2016-17, at 2.4 percent, growth in investments was less than half of the 3.3 percent growth it logged in 2015-16. Quarter on quarter too there has been a steady decline all through 2016-17.
The standard explanation for this subdued investment scenario is stressed corporate balance sheets and banks struggling with the burden of non-performing assets. However, Ashima Goyal of the Indira Gandhi Institute of Development Research (IGIDR), giving a public lecture in Delhi last week, said demand was more of a problem than NPAs (which, though high, is confined to a handful of sectors). Companies are not investing because of excess capacity and this is because of lack of demand, she said.
Worryingly, an India Ratings note suggests that the capital expenditure cycle is not going to revive in the near term. Private companies, the note, put out today, says have shifted their focus to productivity improvements rather than capital expenditure. The problem of low capacity utilisation levels will only lead to higher mergers and acquisition activity in the near to medium term.
So why is there a demand problem when private consumption is growing? Because that may not be enough to address the low capacity utilisation issue. What that needs is huge demand from infrastructure spending. The government is focussing on that – the thrust on low cost housing would help spur this demand. But this is not something the central government can do on its own. The states have to chip in as well – the bulk of infrastructure spending falls in their remit. This is something that should be above politics – better infrastructure should, among other things, help incumbent governments get re-elected.
Then there is the imminent rollout of the goods and services tax (GST), which could lead to some disruption. But this is a necessary step and the Modi government needs to now focus on minimising its negative impact. More importantly, it needs to ensure that there are no more self-inflicted shocks to the economy.
Updated Date: Jun 01, 2017 15:28 PM