Analysis: Did the note ban affect economy?
Niti Aayog vicechairman Rajiv Kumar has said policies on nonperforming assets led to slowdown, not the demonetisation drive
NEW DELHI: In an interview to ANI, Niti Aayog vice-chairman Rajiv Kumar has said that claims of demonetisation leading to an economic slowdown in India are wrong. He said the economic decline after demonetisation should be seen as part of the continuing trend of declining growth rate since the end of 2015-16.
This, Kumar said, was due to decline in bank credit to industry as banks could not lend due to rising non-performing assets. He added that “nobody has brought forth any evidence to show there has been a direct link between demonetisation and slowdown in economic growth rate”.
Economic growth in any given period is an outcome of various factors, especially in an economy as large and diverse as India. Therefore, it is not easy to ascertain the impact of any one factor on the economic growth. To be sure, economists can carry out such estimations using econometric techniques, but even these are based on many assumptions.
For a one-off policy like demonetisation, estimation will be even more hazardous because of lack of any historical evidence.
Chart 1 shows annual growth in bank credit and Gross Value Added (GVA) in the economy. As can be seen, bank credit, especially to industry, had been declining long before demonetisation.
However, the lowest growth came in the December 2016 quarter, which was also when demonetisation was announced. It needs to be kept in mind that India had normal rainfall in 2016 after two backto-back deficient monsoons in 2014 and 2015. This should have given a fillip to market demand and, hence, demand for credit. In fact, this recovery shows in the September 2016 quarter, when both total non-food credit and credit to industry show a break from the long-term declining trend. However, the figures fell sharply in December 2016 once again.
Demonetisation is likely to
have given a double shock to credit growth. Banks were inundated with currency swap-related activities and credit allocation must have suffered, thus administering a supply shock to the system. Also, as consumer demand dried up due to cashsqueeze, companies must have reduced production, leading to an adverse effect on credit growth from the demand side.
Trends in the Nikkei Purchasing Managers’ Index (PMI) substantiate the demand side story. Manufacturing PMI went below 50, which signifies contraction in economic activity, in December 2016. This has happened only thrice since May 2014, when the Modi government assumed office. The other two times it happened was in December 2015 and July 2017; the second was when GST was rolled out. Services PMI went into contraction mode in the month of November itself, and stayed below 50 for three consecutive months. The statistics given above clearly show that demonetisation had a negative impact on economic impact even from the bank-credit channel.
It needs to be underlined that many of these indicators, including GDP figures, are unlikely to capture the full impact of demonetisation on the informal sector, which is where the poorest Indians earn their livelihoods.
Many other studies, including the likes of Economic Survey, which is published by the Ministry of Finance, had themselves noted that demonetisation would lead to short term economic pain.
Esther Duflo, an eminent development economist and a professor of economics at Massachusetts Institute of Technology, was prescient about this in a 2016 interview she gave to Mint.
When asked about demonetisation’s impact on the informal sector and hence India’s battle against poverty, Duflo said, “We do not know that yet and might never know. This is because there is no effective mechanism to measure GDP creation in the informal economy. I was told that informal economy GDP is calculated by indexing it to the formal economy GDP. If that is the case, we might never know the exact magnitude of loss. And the government might use these figures to argue there was no significant setback.”