THE BIG SLIDE
THE GOVERNMENT FACES ITS BIGGEST CHALLENGE YET AS GDP GROWTH SLIPS FOR FIVE QUARTERS IN A ROW. HOW SOON CAN THE ECONOMY BE REVIVED?
OON NOVEMBER 24, 2016, a fortnight after Prime Minister Narendra Modi announced that high-value currencies of Rs 500 and Rs 1,000 denominations would no longer be legal tender, his predecessor Manmohan Singh called it a “monumental disaster”. The move, he said, could set the country’s GDP back by two percentage points. The government was quick to brush away his concerns, and, with growth slowing to only 7 per cent that October-December quarter, argued that demonetisation was being unnecessarily demonised. Economists raised their eyebrows then, warning that the GDP figures probably missed the pain in the informal sector, and would come to haunt the government in subsequent quarters.
And they did. On August 31, the Central Statistics Office said GDP growth had slipped to 5.7 per cent in the April-June quarter, the lowest in three years. The big disappointment came in the manufacturing sector, which grew at a five-year low of 1.2 per cent, down from 10.7 per cent a year ago. A day earlier, the Reserve Bank of India (RBI) had said most of the demonetised currency was back in the banking system (99 per cent of the demonetised Rs 15.44 lakh crore). And contrary to the hope that some Rs 3-to 4 lakh crore worth of black money would be ‘destroyed’, RBI’s surplus payable to the Centre out of its earnings for 2016-17 more than halved to Rs 30,650 crore from a year ago. Incurring extra cost in printing new notes, and making additional provision of Rs 13,140 crore for a contingency fund, the central bank was left with little surplus cash to spare.
Beyond the immediate hardships of demonetisation—serpentine queues where over a hundred deaths were reported, delay in bringing in new currency as 200,000 ATMS had to be recalibrated, the dearth of lower denomination notes—the backlash on the economy has been painful.
Informal sector pangs
With several small manufacturing units downing shutters as owners defaulted on cash payments and sales plunged, the unorganised sector bore the brunt of the exercise. “Consumer expenditure, almost the sole demand component driving the economy, slowed, and the cash-dependent informal sector was hit,” says Ashima Goyal, professor at IGIDR (Indira Gandhi Institute of Development Research). Credit rating agency Crisil, meanwhile, said the cash crunch hurt economic growth, especially of small enterprises, while GST led manufacturers to curtail production and exhaust all inventory before it was rolled out on July 1. As many as 1.5 million jobs were lost in the first four months of 2017, ostensibly due to demonetisation and a continuing fall in new investments, said the Centre for Monitoring Indian Economy (CMIE).
Government under attack
The data has rattled the government, which has been projecting India as the world’s fastest growing country ahead of China. It has now lost that position: China grew 6.9 per cent for two consecutive quarters of the calendar year 2017. It has seriously hurt the growth narrative of the Modi government, which came to power on a development and anti-corruption plank and has to face the electorate in less than two years. Smelling blood, the Opposition was quick to attack Modi ahead of the cabinet reshuffle on September 3. “If reshuffling is happening on the basis of work, then Prime Minister Modi should be included,” said Congress leader Ghulam Nabi Azad, holding a host of issues, including demonetisation, against the government. Finance minister Arun Jaitley, however, said that the fallout of demonetisation was on “predicted lines”. “The fact that money got deposited in banks doesn’t make it legitimate money,” he said, referring to the 1.8 million accounts said to be under the income tax scanner post-demonetisation. Faced with the latest GDP numbers, though, he did concede this: “Data throw up challenges for the economy. We need
The new GDP data has rattled the government, which had been projecting India as the world’s fastest growing economy, ahead of China
to work more on policy and investment in the coming quarter.”
DeMon, the villain?
Was demonetisation too drastic a measure causing too much collateral damage, even if it was wellintentioned? Did the government act in undue haste in imposing a policy that would cause major economic disruption? Did it follow it up with an equally disruptive GST, that has, even if in the short run, created much confusion in businesses, with multiple tax slabs and cumbersome filing of returns? Perhaps, yes, say experts, given that the moves came at a time of promising macroeconomic numbers. Fiscal deficit (the difference between government expense and revenue) had declined from 4.5 per cent in 201314 to 3.5 per cent in 201617, and seemed on track to meet the current 3.2 per cent target. CPI inflation (price rise of a basket of commonly bought goods and services) remained under control for the third successive financial year; though it rose sharply to 2.36 per cent in July, it was still below the government’s inflation target of 4 per cent. India’s trade deficit (difference between exports and imports) fell from its highest level of $190.3 billion in 201213 to $118.7 billion in 201516, while foreign direct investment in April to December 201617 was $31.2 billion compared to $27.2 billion last year. Economists say the government may also have lost out on the opportunity to turbocharge India’s growth in a good year, with nearnormal rains, record foreign direct investment, low inflation and low crude oil prices.
To be sure, demonetisation and GST are not the only reasons that pulled down economic growth. Agriculture is hurting despite a good rainfall last year, with growth falling to 2 per cent in the first quarter of 201718 (compared to 4.9 per cent in 201617), India’s gross value added—the value of goods and services produced in the economy after deducting input costs—slowed down to 5.6 per cent in the first quarter (it was 6.6 per cent in 201617), industry capacity utilisation slipped to 71 per cent and the Index of Industrial Production slowed down from 5.2 per cent in July 2016 to 2.4 per cent a year later. Overall growth has slowed five consecutive quarters, and the government’s target of over 7 per cent growth this year seems ambitious.
“I equate India with a house under renovation: several longheld norms are being challenged; new and more efficient rules are being written,” says Neelkanth Mishra, managing director and India Equity Strategist at Credit Suisse. “We did expect the growth slowdown.” Mishra says several structural changes are currently afoot in India. With agricultural income growth stalling, millions of workers will be forced out of farming; GST is disrupting not only in expected ways of improving in direct and direct tax compliance, but also in upending margin structures in supply chains, forcing shops to register themselves and upgrade their billing software; the Real Estate (Regulation and Development) Act (RERA) has led to a slowdown in property launches; and bankruptcy code action has picked up, with several companies that defaulted on loans being referred to the insolvency process. “With so many structural changes going on, it is hard to isolate the impact of one change,” he says.
D.K. Srivastava of consulting firm EY says the fall in growth is partly due to demonetisation and partly in anticipation of GST. “The pain is likely to last the next 69 months, a transitional period for GST,” he adds.
Pranjul Bhandari, chief India economist at HSBC, believes that slowing growth is not just an effect of demonetisation that will reverse with remonetisation. She points out that growth had begun to slow down from mid2016, well before demonetisation. “In our view, it was led by the rolling off of the oil bounty. This driver of growth does not exist any more,” she adds.
Manufacturing woes
Running a small garment export factory in Tirupur, a textile hub in southern Tamil Nadu, Anand Ram says GST has led to a spike in raw material cost, hurting his annual turnover of Rs 3 crore. His business is still struggling 10 months after demonetisation, his staff down by half, and profit margins 40 per cent lower. While the government’s highdecibel ‘Make in India’ campaign could do little to revive the country’s manufacturing, demonetisation and GST have put the tottering sector on the backfoot once again. In a study in late August, the RBI said the net profit of 2,726 nongovernment and nonfinancial companies declined by 6.9 per cent in the quarter ending March 2017, even as sales improved by 7.2 per cent. Small companies with a turnover of less than Rs 25 crore reported a massive 57.6 per cent fall in sales for the quarter.
India’s growth story was anchored by the booming services sector, which has taken a hit, but may perform a little better this financial year. Trade, hotels and transport are expected to improve (given that agricultural production remains robust and construction activity is expected to gather pace). Financial services, real estate and professional services are also expected to improve due to better performance of the capital markets and a pickup in consumer credit as banks lower their lending rates. Crisil expects the services sector to grow at 8.1 per cent in fiscal 2018 compared to 7.7 per cent the previous year.
But what has the policymakers worried is the slowdown in labourintensive sectors, such as construction, which may
Economists believe that with two big resets, the government may have squandered an opportunity to turbo-charge growth in a good year
have resulted in job losses in both the formal and informal economies. Harsh Neotia, chairman of the Ambuja Neotia Group, says, “The effects of RERA and GST are playing out. Compliance requirements of both will take time for people to adjust.”
Demonetisation hurt the informal economy and triggered a rush for distress labour under schemes such as the National Rural Employment Guarantee Act, according to the midyear Economic Survey. The impact of demonetisation was stronger in “less developed states”, topped by Bihar—with a 30 per cent hike in demand for distress jobs over previous years, the survey reported.
Credit offtake slips
Bank loans to businesses and services continued to shrink in the first four months of 201718. Overall bank credit growth in the current fiscal (as on August 18) was at a historic low, with banks’ loan books shrinking by Rs 1.37 lakh crore. The only increments were in credit card outstandings, which grew 9 per cent, and auto loans, which grew 1.2 per cent, according to RBI data. Home loan growth was just 0.4 per cent. “The slowdown in the real estate sector remains a concern,” says Gulam Zia, partner with realty consultancy Knight Frank. Demonetisation followed by RERA, which makes project planning and marketing norms stringent for developers, was aimed at cleaning up the sector, but could end up harming it in the short run.
With companies, especially in the infrastructure sector, defaulting on their loans, non performing assets (NPAs) of listed public and private sector banks ballooned to Rs 7.7 lakh crore in March 2017, according to Bloomberg Quint. With a new insolvency law in place, the RBI has identified several large corporate defaulters for proceedings. But the process can be long and painful, with many companies likely to challenge the process in courts of law.
Worse, the RBI urban consum er index shows a sharp fall in June, even lower than when Modi took charge. This sharp fall in consumer confidence is further corroborated by the MasterCard Asia Pacific Survey of 18 Asian countries, according to which the dip in consumer confidence in the first half of 2017 was the most marked in India.
Revival hopes
How long will the pain last? Crisil has trimmed its fiscal 2018 growth forecast for India by 40 basis points from 7.4 per cent to 7 per cent. “We believe the sharp decline in growth in the first quarter is transitory and the economy will grind up slowly over the next few quarters as the impact of demonetisation and destocking fades,” it said. Most of the top economists india today spoke to have scaled down their expectations of growth for this fiscal (see Now What?)
Credit Suisse’s Mishra says the economy needs both monetary and fiscal stimulus to revive. As the government has tightened the fiscal tap (aggregate spending growth by state and central governments is budgeted to be the lowest in a decade this year), banking system loan growth is at multidecade lows, and financial savings have risen, there is a surfeit of capital and not enough demand. “The cost of capital must fall—in the equity markets that has meant high valuations, but interest rates must come down as well,” he says. With private investment struggling, the government increased public expenditure on a host of areas, including infrastructure. Government spend moved up sharply since the June 2016 quarter, increasing by double digits in the December 2016 and March 2017 quarters. State governments have also ramped up capex on irrigation, roads and metro rail projects. But more needs to be done.
While one school of economists says that the government should ease its 3.2 per cent fiscal deficit target, EY’s Srivastava thinks it can stimulate the economy even while
sticking to it. Neotia says that if interest rates come down, private investment will see a turnaround in the next six months.
Policy boost
The fall in GDP growth to a three-year low has jolted the government. The plan, say sources, is to chalk out a revival in six months, and address certain critical areas that need pump priming, including exports, steel, power and mining. “The situation is as grave as 2008, when the economy was threatened by global headwinds set in motion with the collapse of Lehman Brothers,” says a source. Akin to the fiscal stimulus initiated in the days and months after the collapse of the global financial markets, the government will initiate measures that can revive the economy. A major focus area would be the recapitalisation of banks and massive public expenditure.
“The needs of the economy are so huge that private investment alone cannot address them,” the source adds. Any higher spending on infrastructure will have a multiplier effect. Job creation is also high on the agenda. Also, since an appreciating rupee has begun to hurt
Indian exports—growth slid to an eight-month low of 3.94 per cent in
July—India could relook at its exchange rate policy and curb the currency’s appreciation. To make up for any fiscal shortfall, the government could take advantage of the positive market conditions and go aggressive with its disinvestment agenda.
The government also believes the economy could have bottomed out and a turnaround could come as early as in the September quarter on the back of a good monsoon. It also cites the uptick in direct tax collection in April-July—up 19 per cent from a year ago—as a success of demonetisation and expansion of the tax base. Demonetisation and GST, say policymakers with the government, should be seen as part of the government’s drive to end black money. As many as 37,000 shell companies were complicit in shielding black money, they say. According to the finance ministry, the tax department, for the first time, will deploy sophisticated data mining to track such cases. Demonetisation has forced transactions to move from the shadow to the real economy. And while the second quarter of this fiscal could also be bad, the third quarter could see a revival with growth at near 7 per cent, say ministry sources. The hope seems earnest, the outcome could be a different story.