No demonetisation impact on India’s GDP growth? Too good to be true | Opinion
The India growth story is actually much more dismal than is indicated by Central Statistical Organisation’s robust Q3 GDP numbersanalysis Updated: Mar 05, 2017 06:39 IST
What do the latest third quarterly gross domestic product numbers indicate regarding the impact of demonetisation? This is the most authoritative take on what happened since November 8, 2016 when roughly 86 % of cash was taken out of circulation. Virtually all economists believe this disruptive event contracted India’s output of goods and services or GDP. Their differences are on the extent and whether the collateral damage to growth is only short-term or more long-lasting in nature. The second advance estimate of GDP growth that takes into account more data regarding demonetisation, however, has pegged growth for 2016-17 at a robust clip of 7.1%. This was same as the first advance estimate.
Prima facie, a shock to the cash economy lowers GDP growth as consumer spending takes a massive hit. When cash accounts for 78% of consumer payments, the sharp reduction in money supply brings spending to a grinding halt. People become more tight-fisted as there is uncertainty as to how long the cash crunch will persist. Retail trade and transportation of goods gets seriously impacted in this milieu. The cash-dependent farm economy is also affected as farmers do not get paid for the crops that have been harvested as happened during Sankranti or Pongal in South India earlier this year. They did not have money to pay for fertilisers and seeds in the on-going winter or rabi season.
Growth is bound to be affected as investment of the private sector continues to be extremely sluggish. The banks are seriously stressed with rising non-performing assets to make advances to industry, especially small and medium. The ongoing cash crunch has also dealt a body-blow to the informal sector that accounts for 45% of GDP and 80% of employment. As the informal sector is not covered in the GDP numbers, it is proxied by indices like the Index of Industrial Production that is more representative of formal manufacturing. The sharp decline in manufacturing in the IIP in December 2016 or overall GDP estimates severely understate the devastation in the informal sector.
For such reasons, the India growth story thus is actually much more dismal than is indicated by Central Statistical Organisation’s robust Q3 GDP numbers. Growth is higher than the pollsters widely expected at 7% in October-December 2016. This implies that growth will be a tad slower at 6.8% in Q4, January-March 2017, to reach the second advance growth estimate of CSO of 7.1% for 2016-17 as a whole. On the face of it, this is indeed puzzling as it would contradict official narratives that matters are definitely expected to improve every successive quarter as newer notes have got into circulation in the last few months to restore normalcy in the cash economy. Whether this is statistical or reflective of underlying trends deserves closer attention.
The latest CSO numbers are a tad higher than the 6.6% rate for 2016-17 indicated by multilateral agencies like the International Monetary Fund. Under Article IV of its Articles of Agreement, the IMF has bilateral discussions with all its members. The 2017 report for India admits that a key domestic risk is the NDA government currency exchange initiative “where the near-term adverse economic impact of accompanying cash shortages remains difficult to gauge”. India’s average growth in Q3 and Q4, notably, Oct-Dec 2016 and Jan-Mar 2017 is forecast to be 6%. In sharp contrast, CSO’s numbers imply a much higher average growth trajectory at 6.9% in Q3 and Q4, which suggest that cash shortages may not have adversely affected growth as popularly thought.
What about the future? There is no doubt a lot of persisting uncertainty when the cash economy gets going again although CSO’s numbers suggest that the worst is perhaps over. The latest Economic Survey pegged growth in 2017-18 at a more rapid clip of 6.75% to 7.5%. At the third meeting of the Monetary Policy Committee, the RBI governor noted that remonetisation of the economy has been taking place at an accelerated pace. Economic activity thus is expected to pick up from the latter part of Q4 of 2016-17, although CSO number is a bit lower. Discretionary consumer demand is expected to bounce back. All of this makes for improved growth prospects for 2017-18.
N Chandra Mohan is an economics and business commentator based in New Delhi
The views expressed are personal.