GDP growth in the fourth quarter of the previous financial year, 2016-17, has turned out to be below the expectation of most economic analysts. The median forecast of 36 economists polled by Reuters showed a growth rate of 7.1%. The official figure of 6.1% is below the lowest prediction of 6.5%. But the surprise is that the actual number should have been even lower than 6.1%, given the ground reality. Surveys showed in December and January that demonetisation, the biggest economic event of 2016-17, had severely dented major parts of the economy.
Prime Minister Narendra Modi had announced that there would be pain for 50 days and later modified it to say that the pain would become less after 50 days. Pain meant that there would be economic hardship due to demonetisation. The image of soldiers standing at the frontier for the country was invoked to exhort citizens to bear the pain willingly for the greater good of the country. The Indian people have not failed the PM.
What was the pain felt by the people? People, instead of going to work, stood in lines at the banks. In the harsh winter months, people with quilts queued up during the night and slept in the lines outside the banks. Many lost work and had to go back to their villages. The demand for MGNREGS work shot up in December and January. While Rs 38,000 crore had been allotted for it in the previous budget, the actual expected expenditure was Rs 47,500 crores. The extra demand was Rs 9,500 crore, which translates over two months to 150% increase in monthly expenditure. Many small and cottage businesses closed down, affecting output and employment. Jamshedpur, Aligarh, Ludhiana and so on reported large scale impact on their industries. Reports were of small traders, wholesale markets and transporters being adversely affected. Even sales of luxury cars dipped for the first time in 25 years.
The economy consists of two parts: the organised and the unorganised. The organised sector is the large and medium scale units which depends much less on cash. The unorganised sector consists of the small and cottage sectors and agriculture. These depend heavily on cash transactions due to habit and lack of access to formal money markets. So, a cash shortage caused by demonetisation did not affect the organised sector as much as the unorganised sector.
It is the unorganised sector which was badly hit by the demonetisation-induced shortage of cash. The RBI has not yet released figures for how much of the old currency has come back but this author’s analysis shows that by January 13, 98% of the Rs 15.44 lakh crores of demonetised notes had come back into the banks. However, by then, the currency in circulation with the public had only come to half of November 8, 2016 levels, which is when demonetisation started. Even by the end of April, remonetisation had taken the currency in circulation back to only 80% of what it was on November 8, 2016.
Agri growth only on paper
So, currency shortage continued well into May and that is why there have been persistent reports of shortage of cash in ATMs even now. This continues to effect the unorganised sectors of the economy. Reports in November and December showed an impact on up to 80% on the non-agriculture unorganised sectors. Even in February, reports were that while workers returned from villages they could not get employment.
Agriculture was also adversely affected with delay in Rabi sowing in North India and collapse in prices of vegetables. Farmers distributed vegetables free in Ranchi because taking it back to the farm was more expensive. Tomatoes and potatoes were thrown on the roads because of unremunerative prices. Partly this was a result of the higher output but there was also a reduction in demand due to cash shortage and rise in unemployment. So, while output increased, a larger part of it than usual was lost due to wastage. So, agriculture’s rate of growth can be taken to be less than on paper.
The question is how is all this factored into the data handed out by the government. While the government gets some data from the organised sectors of the economy fairly quickly, even this is not very robust and is often revised. Consequently, the government gives advanced estimates and then revised ones and this process of revision goes on for several years – the final data sometimes takes several years. This would be especially true when there is a big shock to the economy and data for 2016-17 can be expected to be revised considerably in the coming quarters and years.
Government agencies have admitted that they do not have data on the non-agriculture, unorganised sectors of the economy. The chief economic adviser and the chief statistician of the country have admitted as much. However, they have made little attempt to try to rectify this big gap for the post demonetisation phase of economic growth. They should have been working overtime to inform the public about the impact rather than only repeating that they do not have the data. This is what is opaqueness and lack of transparency. Is there a political angle to this?
Chief statistician TCA Anant is helpless because he is unable to clarify matters further and seems to want to politically defend the government’s stand that demonetisation had little impact on the economy. The finance minister, recently at the third anniversary of the NDA government, said that there was no impact of demonetisation. Is the former justifying this stand of the government?
First, Anant said analysts should not jump to conclusions on the basis of limited data in one quarter. At the time of announcing the results, he said, “Analysis …. cannot be done through post hoc ergo procter hoc. Because it is after this, so it is because of this…” The next day he was even sharper in his comments, stating that note ban hit is overstated by pre-conceived notions.
The issue is that he, as the chief statistician of India, has more data available than anyone else in the country and he has more analysts working on data than any other agency. Why has his department not come up with a proper analysis of the impact of demonetisation in the last seven months? This is a long enough period of time for a competent economist to say something more definitive than what he has been saying. If he did what he should have then no one need guess what is happening to the economy post demonetisation.
At least he could have clarified whether the methodology of calculation of quarterly and annual advance estimates of GDP or GVA apply in a situation where there is a demonetisation-like shock to the economy? If it was a shock, then what kind of shock was it and how much impact is there likely to be after separating out the past trends? Is it not the case that if the shock was large enough, it would overwhelm any trends from the past? What we get instead is opaqueness all the way.
For the last year, the Modi government has consistently maintained that India’s economy is on the upswing and doing well. Suddenly now it is saying that the economy has been slowing down for the last few quarters. The slowdown in Q4 FY’17 is now stated to be a part of that trend of rate of growth declining from 7.9% in Q1 to the present 6.1% in Q4. Data suggest that even this latter figure was buoyed by the massive growth in ‘public administration, defence and other services’ which grew at 17%. Industry grew at a higher rate because of the revision of the way IIP is calculated otherwise the rate of growth would have been even lower. Agriculture is also being assumed to have grown faster but the negative factors mentioned above have not been accounted for.
For agriculture, data on crops and the areas sown for each of them is collected routinely. So, an estimate of the production can be made fairly quickly. However, net output would be lower due to wastage. The problem is for the non-agriculture unorganised, sectors consisting of Q4’s services and industry – industry, trade, finance and so on. No data is collected for these activities. It is periodically collected every three to five years. Thus, the question arises as to how does the government calculate how this part of the economy is doing and how to get data for most of the unorganised sector?
Data based on the new series for 2011-12 suggests that about 45% of the output of the economy comes from the unorganised sectors. The old series had put it at over 50%. Assume that these percentages still hold for 2016-17. Agriculture is 14% and it can be taken that data for this sector is available. So the balance is non-agriculture unorganised sector and it amounts to 31% and it is for this sector that the government does not have any direct data.
So, for close to one third of the economy, data is not available. Then, how can the actual rate of growth of the economy in the post-demonetisation phase be given with any certainty? The truth is that government’s database for calculating the economy’s growth is incomplete. The RBI and ministry of finance have admitted that they cannot tell the impact of demonetisation on this part of the economy.
Inches and centimeters
Analysts in the government, based on expert advice, have devised methods to calculate the contribution of this part based on what is happening to the organised sector and by looking at labour productivity and employment in the unorganised sectors.
However, none of this applies in abnormal times like, when there has been massive cash shortage. The usual methodology of calculating the contribution of the unorganised sector to GDP would not apply and if used would be incorrect.
The days, weeks and months after November 8 was not a normal period of time. While the organised sector was hit less, the unorganised sector was hugely impacted. So, the ratios available from earlier data of organised and unorganised sectors would not be relevant. There was massive unemployment in the latter so one cannot project from the pre November 2016 data. A new methodology was needed but this is nowhere in sight.
Most analysts turned out to be wrong because their forecasts are based on government pronouncements. They have not questioned the methodology used to calculate GDP when there is a shock to the economy. Why? For the financial analysts polled by Reuters, it is crucial that they give correct analysis because they advise people on investments. Mistakes by them or a wrong reading of the situation by them costs people a lot of money. As chief economic adviser Arvind Subramanian has recently stated, most experts are sycophantic. He said that they literally toe the government line.
International agencies also do not collect independent data and also more or less give data which is close to what the government says. They are often constrained to give out their analysis in consultation with the ministry. So, there are few independent voices which can hold government to account.
Soon after the people’s difficulties started mounting and industry and trade started to complain of adverse impact due to demonetisation, the government’s analysts began saying that there would be a quick V shaped recovery. What it means is that after a sharp dip in the economy there would be an equally sharp rise. Analysts bought this line without doing their own proper macroeconomic analysis.
The government data suggests that there was hardly any impact on Q3 (September to December) numbers with the economy continuing to grow at 7%. So, where was the sharp dip? Analysts should have questioned this. Now instead of a sharp rise, government data shows a further fall. So, those who accepted a V shaped behaviour theory need to take another look at their assumptions.
A short-term shortage of cash for 15 to 20 days would have reversed itself quickly as this writer pointed out in November 2016. Anything longer would have a more permanent impact. This is especially so when the other major macroeconomic factors are taken into account.
Credit off-take from banks was at a historic low in October 2016 and declined further, suggesting a slowing economy. NPAs were already high and would have only increased after the slow down in the economy. Demonetisation added to that slow down. Capacity in much of industry was down to about 75% and demonetisation would have made it worse. So, private investment which was already low deteriorated further. This has a long term impact on the economy and delays any possibility of recovery.
The government could have increased demand by increasing its fiscal deficit but that was not allowed to happen since global credit rating agencies would have frowned on that. The government claims that it collected much more taxes than earlier and that would dampen demand in the absence of enhanced expenditures by the government. Exports did see a surge but so did imports with the result that the external sector did not provide a stimulus. Post Trump and Brexit, there are more uncertainties on the export front and it is difficult to visualise a stimulus from this source.
Much store is laid on an increase in consumption. This is a statistical illusion. When the investment rate of the economy declines then the consumption ratio rises (all else remaining the same), but that does not mean a rise in aggregate consumption. In fact, consumption from the unorganised sector would have contracted even if it remained unaffected in the organised sectors of the economy. Reports of slowdown in FMCG sector and two wheelers and other sectors suggests that.
The issue of growth in the economy is not an emotional one or one of politics. It is about reality on the ground and of hard data – how is the economy doing post demonetisation?
A simple calculation with some reasonable assumptions on the unorganised non-agriculture sector based on the few private surveys available from December to February would suggest that the rate of growth of the economy in November 2016 to January 2017 would be negative and in February-March 2017 possibly close to zero. That is why demand is low and so is capacity utilisation.
What is the likely scenario in the coming quarters? Quite dismal given that credit off-take is not robust, NPAs continue to rise, employment is down and so is capacity utilisation. So, private investment is unlikely to show any rise. Any increase in government expenditures cannot compensate for this continuing decline with the self imposed constraint of keeping fiscal deficit to 3%. Export stimulus is very uncertain given the global situation.
In this post-truth world, analysis on the basis of partial data should not be allowed to trump reality. The economic picture is far from rosy as the government is trying to depict and demonetisation has played a big role in that no matter what the government says.
Arun Kumar is an economics professor, formerly at JNU, and is author of Indian Economy since Independence: Persisting Colonial Disruption.