The survey does not lift the mist of confusion over India’s macroeconomic situation after demonetisation, while the conservative fiscal stance proposed will only lead to an aggravation of the problems confronting the economy.
Economic surveys assess the performance of the economy in the financial year. They identify the problems faced. They also give some inkling as to what the official thinking is about how these problems may be tackled in the following year and especially via policies in the Budget that is to follow. However, it is often the case that the Budget does not address these problems, or not in the way that may be presented in the survey.
Real rate of growth
The Economic Survey 2016-17 needs to ask and answer some crucial questions about the year that has just passed in which a major economic event occurred, namely, demonetisation. Field reports suggest that the wholesale trade is even now down by 20% to 30% which suggests that retail demand is still slack two and a half months after demonetisation was announced. Immediately after the announcement, wholesale trade was reported to have declined by anywhere between 60% to 80%. Such a sharp decline in trade and other reports from the field from industry suggest that the economy is facing recessionary conditions. Output and investment are reported to have contracted and unemployment has increased especially in the unorganised sector. While the organised sector is less affected the unorganised sector has been hit badly. The latter employs 94% of the workforce and produces about 45% of the output.
Yet, the Economic Survey projects a growth rate for 2016-17 of 6.5%. How is this arrived at if there has been negative growth in large parts of the economy since November 2016? The survey itself admits that the unorganised sector data are not directly captured in the Index of Industrial Production (IIP) because it does not directly measure this sector’s contribution and assumes it to be in proportion to that in the organised sector. Demonetisation has led to a delinking of the growth rates of the two sectors, so that IIP does not anymore reflect the growth rate of industry.
Under different assumptions – specifically about the impact on the organised and the unorganised sectors of the economy since November 2016 – it can be shown that the rate of growth of the economy would drop sharply from 7% pre November 2016 to about 2%, 0% or even negative for the year as a whole. Just how low the growth may be is hard to estimate at present due to the limited data available.
The problem is further compounded when it comes to predicting the rate of growth for the coming year, 2017-18. What should the projection be based on? The average of the previous year (2016-17) or the trend from November 2016 when the big shock to the economy was delivered? The average of very disparate numbers is not the representative number to base one’s projection. Further, the conditions that prevailed before November 2016 were very different from those after that month. Hence they are no more relevant for projecting the numbers.
Irreversibilites have set in
It is suggested by the survey that the situation of the economy would reverse quickly once cash shortage is over in a few months’ time. However, it is not taking into account the irreversibilities that the economy encounters whenever there is a large shock. An economy is about society and people and not about some science experiment where one can replicate conditions for an experiment.
When employment falls, profits fall and investments are cut back. That is when irreversibilities arise. After November 8, 2016, demand was hit all round, production slowed down, profits fell and all of that led to unemployment and decline in investments which leads to long-term effects. Even if the note shortage becomes less, as it is bound to happen, demand does not revive on its own and the cycle does not reverse.
Clearly, the government is not willing to admit (for political reasons) that there has been major pain in the economy and therefore, it is still talking of a 6.5-7.5% rate of growth. This means that it is planning on the basis of incorrect data. If the Budget is also based on these incorrect figures and understanding of what is happening in the economy, there will be serious consequences for the economy. It also implies that the government will not do what is required to be done to overcome the current problems. This could further deepen the recession in the economy and make the problem worse.
A conservative fiscal stance
The survey has talked of a cautious fiscal stance. What is forgotten is that in 2008, when the economy was hit by the global recession, what saved the day for India was a rapid increase in the fiscal deficit and massive expenditures in rural areas under various schemes. India was not alone in that. All the countries in the world boosted their public expenditures by boosting the deficit in the budget. China in fact went in for a $600 billion rural infrastructure programme and so on. In the present situation of recessionary conditions, a cautious stance would lead to a decline in demand since tax revenue would not be buoyant given the slowdown in the economy.
The survey also talks of giving tax concessions to the corporates by accelerating the promised cut in their tax rates. There has also been talk of giving concessions to the middle class and the rich by lowering income tax rates. These would lead to a fall in the tax collection in the present situation of slowdown. This would mean that either the fiscal deficit would rise or there would be cut back in expenditures. The former is ruled out by the survey under the rubric of a fiscally conservative stance and the latter can only deepen recessionary conditions. The Budget therefore is in a pincer. The government has to make bold choices but the survey rules that out.
The black economy, if tackled effectively, could have given additional resources for the Budget. However, the Survey does not give a lead as to how that could happen. Demonetisation has not managed to unearth any major chunk of the black economy or make it come into the formal economy.
The Survey suggests that stamp duties should be lowered in the hope that black income generation in real estate would decline. However, this is based on the false premise that real estate generates black income. Actually, it circulates black money since the incomes earned here are in the nature of `transfer incomes’ where assets change hand and production does not take place. Analytically, this is not understood in the Survey so lowering of stamp duties would not deter black income generation in real estate.
How long will the pain last?
The pain related to cash shortage maybe getting less (although rural areas are still hurting more) but the bigger problem now is the recession. The public is curious to know how much black money demonetisation unearthed but the government is not providing any answer to this as yet. The irony is that those who never generated black incomes have faced all the pain while those who generate black incomes and have black money have escaped through various devices. They have largely managed to recycle their old notes into new notes in connivance with the corrupt in the system. No wonder according to unofficial reports, most of the old notes have come back into the banking system.
It also needs to be kept in mind that cash does not automatically mean black money. A lot of cash is used in the white economy for purposes of transactions, working capital by businesses and also as precautionary motive for any illness or an emergency. The banks cannot declare the money deposited with them as black. The income tax department has to do that but after following procedures. They can ask for the source of the cash deposited in a bank and that may lead to some past concealed income but it is usually difficult to establish that.
Often, the cash is explained away by businesses as working capital. If the money is in the account of poor persons and if they claim it to be their money, there is little that the income tax officer can do. Most of these sums are so small that they would be below the taxable limit and not worth pursuing for the department. Those who have misused the accounts of the poor usually have them under their thumb so they cannot double cross without facing social consequences or losing their job. The cost would not be worth the double cross.
The survey does not lift the mist of confusion on the macro situation of the country and does not provide clarity on what happened due to the big shock to the economy on November 8, 2016. It is in a state of denial and that is what is creating a problem for the economy. The conservative fiscal stance being proposed will only lead to an aggravation of the problems confronting the economy. The government and the country are trapped because demonetisation was ill-advised. It does not check the black economy but the government pretends that it does. It is causing the Indian economy to slip into a recession and that is hurting everyone and especially the poor who had nothing to do with black income generation. But the pain of the marginalised (not captured by the Index of Industrial Production) is far greater than can be ameliorated by the few sops that are offered to them.
One needs to admit the problem to solve it and that is not forthcoming in the Economic Survey 2017.