Alarm bells have been set off by the latest quarterly GDP growth figure of 5.7%. Growth has been declining for six quarters. GST, supposedly the biggest tax reform in the country since independence, was expected to boost growth but that expectation has been belied. Most analysts agree that the adverse impact of demonetisation and GST is manifesting itself.
Recent reports of job losses in the organised sectors and rising inflation rates have added to the sense of crisis. Rainfall has been inadequate in about 250 districts, which means the kharif crop is likely to be less than last year and this could worsen the crisis in the farm sector. Due to the poor design and implementation of GST, there is much confusion and the trading community and small producers are agitated. The youth has also been protesting against the lack of employment opportunities.
If the economy does not revive soon, the ruling party could face a difficult task in the coming elections and the 2019 general election. The only silver lining for the BJP is the absence of a coherent opposition to take advantage of the adverse economic situation.
Rate of growth is even less
The problem is bigger than what official data indicates. A 5.7% growth rate is not bad compared to what other major economies of the world are experiencing. It is also healthy compared to India’s own 70-year record. So, what is the problem?
The 5.7% figure is an estimate of the quarterly rate of economic growth, which is largely based on the data provided by the corporate sector and some other organised sectors of the economy. Data from the unorganised sectors of the economy is not included. The non-agriculture component of this sector contributes to 31% of the GDP. It is this sector that has been hit hard by demonetisation and GST. If almost one-third of the economy is hit hard, the growth rate ought to be far lower than 5.7%.
This is a different argument than saying that growth was boosted by 2% in 2015 because of a change in methodology. To be fair to the present government, this change was initiated by the previous regime. But, if the present dispensation accepts the new methodology then the previous UPA government did not leave an economy in shambles as the proponents of the present NDA government argue.
Two shocks hit the unorganised sectors
So, where does the problem lie? It is that the method used to estimate the quarterly rate of growth of the economy does not give the correct rate of growth when there is a shock to the economy. Demonetisation was a major shock to the economy and especially to its unorganised components. Demonetisation set into motion a long term trend of slowdown in the economy. This is still playing out.
This shock was followed by another shock due to GST, which led to huge uncertainty. Not only is its implementation poor, but its design is faulty too. It is intended to benefit the large-scale sectors at the expense of the unorganised sectors of the economy. But as it is implemented, it has damaged the prospects of the large-scale sectors too. Thus, GST has set into motion a further slowdown in the economy.
Some analysts argue that GST will result in the formalisation of the unorganised sector, which will benefit the economy. But the large unorganised sector exists because of its scale, which makes it difficult for it to function like the formal sector. It is a structural problem that will not go away because the government wants it to. It can only damage this component of the economy. So, the argument of formalisation amounts to saying that these businesses would die out and be replaced by the large- and medium-scale businesses in the formal sector. I argued why this would happen even though businesses with a turnover of less than Rs 20 lakh are exempt from GST and those with a turnover of between Rs 20 lakh and Rs 75 lakh have lower tax obligation under the ‘composition’ scheme, which is turning out to be rather complex.
Need for new methodology
The official document, Methodology For Estimating Quarterly GDP, states:
The production approach used for compiling the Quarterly Gross Value Added (QGVA) estimates is broadly on the benchmark-indicator method.
A key indicator or a set of key indicators for which data in volume or quantity terms is available on quarterly basis are used, to extrapolate the value of output/value added estimates of the previous year.
In general terms, quarterly estimates of Gross Value Added (GVA) are extrapolations of annual series of GVA.
What does this imply? Because data is not the available “benchmark-indicator” and extrapolation of “the value of output/value added estimates of the previous year” has to be used.
Two points arise.
First, benchmark indicators are calculated once every few years when data becomes available from surveys. These are not updated continuously because there is not data to do so. Hence, when there is a big shock to the economy and the economic ratios change dramatically these indicators are no longer valid. If used, they lead to erroneous growth rates.
Secondly, extrapolation is invalid when the economy is severely disturbed, like due to demonetisation.
The ‘benchmark indicators’ and ‘extrapolations’ are valid only for the normal functioning of the economy, which was certainly not true after November 8, 2016. What was valid on November 7, 2016, is not valid after November 9, 2016, so extrapolation cannot be used. In brief, the methodology for estimation of quarterly growth rates needed a drastic change both after November 8, 2016, and after July 1, 2017.
An illustration would make this clear. The government’s press note said:
GVA from quasi corporate and unorganised segment has been estimated using IIP (Index of Industrial Production) of manufacturing.
IIP represents the growth in the organised sector. In normal times it can be used to indicate the growth in the unorganised sector. But after demonetisation when the unorganised sector contracted sharply and the organised sector was affected less, not only the ratio between the two changed the IIP growth rate was no more representative.
What could be the rate of growth?
To capture the impact of demonetisation on the unorganised sectors of the economy one needed to conduct surveys between November 2016 and January 2017. A later survey cannot capture what happened during that period. So, government statistics will never reflect what happened in that period.
Luckily, various private surveys were carried out during the period of severe impact from demonetisation and they reported a consistently dramatic decline of between 60-80% in the unorganised sectors of the economy and an increase in unemployment. This is significant since 93% of the workforce is in this sector. All this led to a drastic fall in demand.
According to the RBI, capacity utilisation in the organised industry was low and hovered between 70-75%. There is no data on capacity utilisation in unorganised industry. All this impacted investment adversely and that slows down growth of the economy, way beyond the immediate period of currency note shortages. It is this slowdown that is manifesting itself in the economy even though the data does not show it.
While there is no substitute for government surveys, what data is available from private surveys suggests that the rate of growth of the economy turned negative during the severe phase of demonetisation. It possibly recovered somewhat after January 2017 but it has again declined after June when the GST-related impacts came into play.
This conjecture of a near zero growth is supported by the decline in the credit off-take from banks, fall in employment in the organised sectors of the economy, rise in demand for work under the MGNREGA scheme and the decline in investment in the economy.
Credit off-take declined to a historic 60-year low during demonetisation and further to negative growth in July and August 2017. This reflects the fall in production and investment. This near zero growth is the real cause of worry, which would not be the case if the rate of growth was 5.7%.
The government cites international agencies that also show India growing at near 6%. But these agencies do not collect independent data and use only government data with a bit of interpretation thrown in. They are not giving an independent assessment. It is like the blind leading the blind.
Government in denial
Not taking into account the collapse of the unorganised sector twice over in nine months in the economic growth rate of the economy means that the government is in a state of denial. No wonder it does not think a drastic course correction is needed and mere tinkering is adequate.
Some analysts suggest that the slowdown is due to high real interest rates. They believe the RBI should cut interest rates. But the data on inflation is incorrect.
In India, inflation is measured using the Wholesale Price Index. But that does not contain the rise in prices of services which now constitute 60% of the GDP. So, if telephone and insurance charges or school fees or hospital charges rise these are not factored into inflation. Since it is the services prices that have been rising the fastest in the recent years due to the constant rise in services tax, inflation is underestimated. No wonder the public says that inflation rate is high while the government data shows a low rate of inflation.
The implication is that in India, the real interest rates are not high. Anyhow, when capacity utilisation is low, a cut in interest rates would not lead to an increase in investment (accelerator does not act). Some argue that demand would rise because EMI on big ticket items would fall and people would buy more. In an uncertain environment, instead of spending more, consumers would save more. A 2% cut in interest rates in the last one year has not boosted demand and capacity utilisation remains low.
So if the crisis is to not deepen, one cannot be in denial about the actual data on output, prices and unemployment. This is the catch 22 situation; if the government admits that there is a crisis, there will be political fallout. If not, the crisis will deepen.
Arun Kumar is Malcolm Adiseshiah Chair Professor at the Institute of Social Sciences, and author of Indian Economy since Independence: Persisting Colonial Disruption (Vision Books).