India Will Likely See A Worsening Investment Climate in 2017

Is finance minister Arun Jaitley budgeting in the dark? One can't have a strategy for economic revival without first estimating the economic impact of demonetisation.

The aftermath of demonetisation has created a void in economic data, with the Central Statistical Organisation(CSO) saying its advance estimate of 7.1 % GDP growth for 2016-17 does not factor in the events after November 8. Neither RBI nor the CSO has tried to even provisionally estimate the economic losses caused by the messy re-monetisation programme which is still underway.

Why is the government refusing to give any estimate of the possible economic losses stemming from demonetisation? Someone recently quoted Samuel Beckett: “Any fool can turn a blind eye, but who knows what the Ostrich sees in the sand!”.

One only hopes the ostrich-like finance ministry arrives at some reasonable estimate of the economic losses before presenting the Union Budget. The economic affairs secretary does not appear intelligent when he says ,”We can’t estimate losses based on impressions and anecdotes”. The actual contraction in the sale of consumer durables in November and December is not a mere “impression”. The output and employment loss in a dozen small and medium industry hubs across India is not just some vague impression as the economic affairs secretary would have us believe.

You can’t have a comprehensive strategy for economic revival without a reasonable estimate of the output and employment loss caused by the currency withdrawal.

Things have become even more complicated because the CSO is clearly indicating that an economic slowdown was happening even before demonetisation was underway. The advance estimate shows the GDP growth slowing by 0.5 % in the current fiscal compared to 7.6% in 2015-16.

So if the economy was already slowing before demonetisation, one can well imagine what the negative impact might be after the demonetisation. It is clear now that economist Jean Dreze’s characterisation that the PM had shot at the tyres of a racing car seemed very generous. BJP spokespersons have taken Dreze’s statement as a compliment by flipping the argument and saying that such a massive cleansing of the system was possible only when the economy was doing very well, like a racing car.

Actually, all data released before demonetisation clearly suggest the economy was like a car sputtering at 45-to-50 km per hour. The government had released quick estimates of growth for the first half of the financial year – April to September – in the month of November, right in the middle of the demonetisation drama. The most important data point in that is the sharpest fall in gross fixed capital formation, a measure of investment trend in the economy. The gross fixed capital formation as a ratio of GDP had fallen nearly 4 percentage points in April-September 2016-17 compared with April-September 2015-16. It fell from 31.5 % of GDP (at market price) to 27.6%. A 4 percentage point decline in just one year roughly translates into a decline in capital formation of about $80 billion. The important thing to realise in all this was already happening before demonetisation was announced by Prime Minister Modi. Also note that even at the 2015-16 level of capital formation, there was a steep fall of over 60% in employment generation as indicated by the labour ministry for a dozen select industries. One can well imagine what would be the employment generation in the first half 2016-17 when the capital formation is 4 percentage points less than it was in 2015-16.

There is absolutely no doubt that India’s investment climate was going from bad to worse over the past year as indicated by the gross fixed capital formation figure.  Post-demonetisation, things are probably getting worse. The Centre for Monitoring of Indian Economy(CMIE), widely respected for its rigorous data collation, has said new investment proposals/intentions have actually fallen over 50% since November 8. This is real-time data and not an “impression” or “anecdote” as the finance ministry might want to suggest. In the October-December quarter of 2016, new investment proposals are valued at Rs. 1.25 lakh crore compared with Rs.1.97 lakh crore in June-Sept quarter. The average new investments proposed in the previous quarters are even higher.

So the October-December quarter generally indicates a sharp decline in new investment proposals and within this there is a 60% fall in new proposals during the weeks after demonetisation. The head of CMIE Mahesh Vyas  says a full revival in investment sentiment will not happen until end of 2017. “Industry still is operating at 70% capacity and it tends to increase capacity after crossing 85-90% utilisation”, he said. More importantly, even those planning new greenfield projects will wait to see when the consumer sentiment fully revives. That, of course, will also depend on when the government and RBI allow unrestricted withdrawal of money from banks.

Former chief statistician of India Pronab Sen says, “If the government replaces adequate currency by 31 March and removed all restrictions on withdrawal consumer sentiment might gradually revive in the second half of 2017”. Sen says his worry is rural wage growth was already near zero before demonetisation. If the farmers haven’t got good value for their current kharif harvest, hit by the currency withdrawal, rural consumption may take even longer to come back. One will have to wait and see what prices farmers get for their forthcoming rabi harvest in a few months.

There are too many chaotically moving parts of the economy at this point of time. True, it may not be easy to fully grasp all the variables unleashed by demonetisation. But is the finance ministry even trying? Of course, one can always  live on the hope that the ostrich sees something inside the sand!