Moving Beyond DeMo and GST: Growth Crisis is More Deep Rooted and Needs Tackling

Posting after a long, long time.😊

The economic growth figures released by the Central Statistical Office (CSO) will have the strident critics of demonetisation in a see-we-told-you mode and the ardent supporters more subdued than they have been in a while.

Fiscal year 2017-18 has started out on a dismal note indeed. Gross domestic product (GDP) grew a measly 5.7 per cent in the first quarter (Q1, April-June) against a healthy 7.9 per cent in Q1 of 2016-17.  Other economic data also released yesterday too did not give cheer – eight core industries grew only 2.5 per cent in April-July 2017-18 against 6 per cent in the same period of 2016-17.

For a government that has been patting itself on the back for pulling the economy out of the morass it was in when it assumed power, this is not be welcome news.

The DeMo Deriders insist that the note ban is solely responsible for this worst-ever quarterly growth figures in 13 quarters. However, it would not be entirely factually correct. The other explanation, that the draw down of inventories by manufacturing companies ahead of the goods and services tax (GST) rollout is also responsible, is not the spin that this lot insist it is. It is not just the government that is offering  this explanation; most economic analysts are saying the same. Not all of them will trot out the government line.

It is the combined effect of demonetisation and preparing for GST that saw growth in gross value added (GVA) in the manufacturing sector plummeting from 10.7 per cent in Q1 of 2016-17 to 1.2 per cent in Q1 this year (though base effect could also have played a role). The higher growth posted by the trade, hotels etc segment – 11.1 per cent against  8.9 per cent in Q1 of 2016-17 – shows sales were happening. Anubhuti Sahay of Standard Chartered also  said on Bloomberg Quint that de-stocking has been far more than was expected. It is this manufacturing slump that has pulled down overall GDP growth.

The only sector where demonetisation can be identified as the sole cause of slowdown is construction and real estate. Growth in construction has fallen from 3.1 per cent to 2 per cent between Q1 of 2016-17 and 2017-18. Chief Statistician T.C.A. Anant pointed out that in the `financial, insurance, real estate and professional services’ segment, real estate has done poorly, though he said this was a longer, pre-demonetisation story. But cement production figures in the index  of  core industries also shows a de-growth, month-on-month since November 2016.

But one needs to move beyond the demonetisation explanation. Because the fact is that the economy had been slowing down well before November 2016. This has been said before and has been dismissed as spin, but it bears repeating.

After a blip in Q3 (October-December) of 2015-16 when year-on-year growth fell to 6.9 per cent over the Q2 (July-September) year-on-year growth of 7.8 per cent, there was a rebound to 9 per cent growth (year-on-year) in Q4. But, thereafter, from Q1 of 2016-17, there has been a steady decline, every quarter. Yes, the deceleration sharpened after demonetisation, but it had set in before.

Blaming the slump entirely on demonetisation will give the government a ready excuse – this is an expected but temporary fallout, which will peter out. And it will allow the government to escape an inconvenient question – you promised to put the zing back in the economy, why did it start slowing down under your watch? Have you identified the cause and started  doing something about it? One has to keep the focus on these questions.

Beyond demonetisation and GST, there are clearly some deep-rooted problems that are pulling the economy down. And the signs for the near future are not very good.

Private investment, which is crucial for sustained and robust recovery, is still sluggish. There is a slight uptick in investment as a percentage of GDP – from 25.5 per cent in Q4 of 2016-17 to 27.5 per cent in Q1 of this fiscal. But this is way below what the economy needs and it is not certain if this will sustain.

What is also worrying is that this comes along with a slight dip in private consumption as a percentage of GDP; this has been fluctuating through 2016-17 and in Q1 of this fiscal has dropped to 57.3 per cent. It needs to get back to the around 60 per cent plus levels of the boom years of 2004 to 2008. The economy needs both consumption demand and investment demand. Earlier it was the former which was holding things up, but if this also begins to flag, then there is a serious problem at hand. How much of a boost government spending alone can give remains to be seen. Government expenditure has risen 17 per cent in Q1 and this is because of the front-loading of expenditure thanks to advancing the budget.

Economists continue to debate about whether it is interest rates or other reasons (including the twin balance sheet problem) that are holding up private investment. The government needs to get to the bottom of this urgently and do what it takes to get companies to invest.

There are challenges on the agricultural front too, as evidenced by the difference between the real and nominal agricultural GVA growth (2.3 per cent and 0.3 per cent. This is an indication of a problem in prices and this could translate into a dip in rural demand. A State Bank of India research notes cautions that agricultural growth in the coming quarters could be muted as the monsoons were deficient in key food grain producing states in the first three months.

The laundry list of what the government needs to do at a general level is pretty well  known; it needs to get down to it. The government has moved  on some fronts – subsidy reform, bankruptcy reform, indirect tax reform (though this will be a bit painful initially) – but it needs to move  on others as well – drastically paring down the public sector, banking reforms, to name just two.

The government’s spin doctors are explaining away what is said to be the economic failure of demonetisation by saying the note ban was a political move. The government should now see economic revival as a political matter and do all it takes to get growth back.