As the impact of demonetization is debated, the
World Bank projects a return to 7%-plus GDP growth.
The
article was first published in GARP Risk Intelligence, July 14, 2017; Co-Author- Anisha Sircar
India’s gross domestic product growth rate fell to
6.1% in the March quarter, the final quarter of the 2016-17 fiscal year. The
slowdown was not unexpected; it was merely a matter of how much. GDP growth was
7.3% in the first half of the fiscal year (April to September 2016) and 7.0% in
the October-December period.
All of these numbers are below the 7.9% GDP growth
of the previous, 2015-16 fiscal year, when India was the fastest growing
economy in the world, according to the World Bank’s May 2017 India Development
Update.
In a country where about half the population is
dependent upon agriculture, and where agriculture is, in turn, largely
dependent on the monsoon rains for irrigation, the economy seemed to be poised
for even better growth, with heavy monsoons this year resulting in higher
consumption-driven demand.
Therefore, the fourth quarter GDP data did not sit
well with most economists and critics of the Narendra Modi-led government. It
had demonetized high-value Rs500 and Rs1000 currency notes in November 2016, in
an attempt to root out black money in India. Eighty-six percent of the
country’s currency was demonetized at one go.
Critics claimed that the demonetization was a vain
exercise that resulted in significant inconveniences, delivered a massive blow
to the unorganized sector that is largely cash-driven, caused jobs losses, and
regressed the overall economy.
Weighing the Impact
Government agencies maintained that the impact of
demonetization on growth would be temporary, as GDP data does not encompass the
entire health of the economy, or the total effects of demonetization. This is
particularly significant because demonetization is estimated to have affected
the informal sector of the economy – that which is neither taxed nor regulated
– more than the formal sector. The 7% GDP figure for the third quarter
suggested that the economy was almost unaffected by the demonetization
experiment.
Prof. Arun Kumar, an expert on India’s black
economy, writes in his recently published book, “Understanding the Black
Economy and Black Money in India: An Enquiry into Causes, Consequences and
Remedies,” that demonetization “created great economic hardships for many
millions, and disrupted the economic momentum the country had hitherto
succeeded in building up . . . The black money the government was targeting is
only 1% of the black wealth held in the country, and even if the government
managed to suck out all the black cash in circulation, it would not have much
effect on the black economy which involves various activities in which black
incomes are generated. It does not stop these activities from continuing.
“Moreover, 80% of the Rs500 and Rs1000 notes was
not black money, but rather white money used by businesses and citizens. The
biggest fish were able to quickly convert whatever black cash they had into
white . . . [Also] it was not explained why, when high currency notes were
being demonetized, currency of even higher denomination, i.e. Rs2000 notes,
were being introduced – as this would be even easier to hoard.”
Can we therefore conclude that demonetization is to
be blamed for the slowdown in the GDP growth rate? A closer look suggests that
the economic slowdown began before the demonetization. GDP growth in the second
quarter was lower than GDP growth in the first quarter, and other indicators
such as the gross value added (GVA) were also revealing.
GVA is the value of goods and services produced in
terms of output, minus intermediate consumption, that is, GVA = GDP + subsidies
– taxes. In simple terms, it is output, as measured from the supply side of an
economy.
Tax and Inflation Factors
The increased sales tax collection translates into
higher net indirect taxes (NIT), accounting for a significant gap between GDP
and the lower GVA. The recent growth in tax receipts, particularly from fuel
and metal, was a factor in the difference. Even when global oil prices were on
the rise throughout the year, India did not cut excise duties on petroleum
products, and customs duty receipts on imported metals increased because of
higher commodity prices.
With the rise in commodity prices, and latent demand
becoming rendered after the currency was re-monetized, another factor that came
into play was inflation. Its rise contributed to lowering GDP and GVA even more
in the fourth quarter.
When demonetization was at its peak, the wholesale
price index (WPI) inflation rate stood at 1.8% and 2.1% in November and
December 2016, respectively. WPI inflation rose dramatically following
re-monetization, from 5.25% in January 2017, to 6.55% in February 2017 – its
highest recorded figure in two and a half years. This increase was attributed
mineral and fuel prices.
Consumer price index (CPI) inflation went from
3.17% in January, two months after demonetization was announced and just as
food prices began picking up, to 3.65% in February. (Re-monetisation, it seems,
picked up the pace for consumption-driven demand as well.)
The sudden surge in inflation accentuated worries
of a latent, untapped nexus of demand caused by demonetization. However, more
recent inflation figures reveal that notwithstanding the slight optimism in GDP
numbers, inflation rates began falling to multi-month lows in May, due mainly
to a rarely seen drop in food prices. In April, CPI reached a historic,
multi-year low of 2.99%, compared to 5.47% in April 2016, due to the deflation
in food prices; and WPI dropped to 3.85%, a four-month low.
Macro Indicators Slump
While GDP growth slowed to 6.1% in January-March
2017, from 9.2% a year earlier, the GVA rate went from 8.7% to 5.6%.
The index of industrial production (IIP), used to
approximate activity in informal manufacturing, showed healthy growth in the
first fiscal quarter (April-June 2016) and then began tapering off. Even
investments took a significant hit during the fourth quarter: fixed investment
lowered to 25.5%, the lowest in 13 years; and real fixed investment dropped 2%
year-on-year. High expectations for foreign direct investment this fiscal year
did not revive the private sector; declines in private investment have been
setting back employment generation for many years, but the repercussions of
demonetization on private investments seem to have worsened this problem.
Overall, in contrast to earlier optimism, the
fiscal fourth quarter was harrowing for the Indian economy, uplifted only by
government expenditure and, to a lesser extent, agriculture, without which GDP
growth would have accounted for only an estimated 4%.
Long-Term Rebound?
Economists such as Arun Kumar are not so optimistic
– they say that not only has demonetization failed to effectively tackle the
black-economy problem; it has also hurt the overall economy and the livelihoods
of the poor and small traders who depend overwhelmingly on cash.
Aside from the decline in demand across the
economy, better-off sectors have also been facing uncertainty, cutting back
discretionary expenditure on even “white” goods. All of this, as the figures
reveal, has impacted agriculture, services and industry, and will only serve to
exacerbate the problem of non-performing assets in banks as industrial profits
continue to decline. Since demonetization was announced, unemployment is
believed to have risen, investments fallen, and banks and agriculture facing
growing crises – all in spite of a good spate of monsoons. Many believe that
this could turn the economy toward.
According to the World Bank, India’s fundamentals
remain strong and a re-acceleration of GDP growth, to 7.2%, is anticipated in
fiscal year 2018. A growth rate of 7.7% is projected for fiscal 2020,
attributed to efforts to encourage the recovery of private investment through
infrastructure spending and less crowding of the private sector.
The World Bank assessment concludes that in order
to heighten the potential for growth, productivity enhancements, larger
investments, and increasing the number of women in the labor force of India
would need to be implemented.
