A recent paper by the Reserve Bank of India addresses the concerns associated with the Q3 2017 growth numbers brought out by the government early this month. The official statistics, with their optimistic 7% growth numbers for Q3 2017, suggested that demonetisation had made very little dent in the economic growth momentum. Thus, as per the figures, India’s GDP growth slowed only marginally from 7.4% in Q2, and this exceeded the expectations of 6% growth. On the demand side, private consumption and fixed investment grew, while on the supply side, manufacturing growth accelerated in Q3. It was only the financial, real estate and professional services, which witnessed a slowdown. Such data seemed to be counter-intuitive, given that consumption in particular in India is cash-intensive, and the potential negative impact of the demonetisation-induced liquidity crunch on industrial activity, especially in the unorganised sector.
The skeptics provided three explanations for such paradoxical results. One explanation was that official statistics, based as they are on organised sector data, typically fail to capture the negative growth effects on the unorganised sectors. Second, the downward revision in the Q3 2015 growth numbers to 6.5% y-o-y from 7.2% created a large favourable base effect for comparison. Finally, the practice of companies showing their cash in hand (after demonetisation) as sales may get captured as a higher value addition in these specific sectors. They rued that the discrepancy between official statistics and ground-level data seems to have increased and in fact became glaring post the demonetisation exercise.
Growth post demonetisation
The RBI paper explains the effect of growth on the unorganised sector. Agriculture has a 94.7% share in unorganised sector output, as also the largest share in informal workforce. It is also the most cash sensitive. A healthy progress in rabi sowing in November 2016, which has been much larger than the previous year through February 2017 has been identified as the reason why the impact of demonetisation on production is likely to be muted and transient. Moreover, two successive drought years provided a favorable base effect for the agricultural production in 2016-17, which demonstrated an 8.1% increase. Most of the impact of demonetisation was reflected in the real estate and construction activities in Q3. However, stronger growth in agriculture, manufacturing, electricity, and mining cushioned the overall GVA growth in Q3.
The driver of growth is likely to be the increased investment spurred by the banks reducing their MCLR. The latter itself has been attributed to the surplus liquidity conditions in the banking system which expected to create improved transmission of the cumulative 175 basis points cuts in the repo rate to the lending rates. Better tax reporting and tax enforcement/compliance is expected to generate a positive revenue impact, creating better fiscal space for higher public investment. With rapid restoration in the economic activity in the cash-intensive sectors such as retail trade, hotels and restaurants, and transportation, as well as in the unorganised sector, post remonetisation, the business climate is expected to improve. India can then witness the medium term positive effects of demonetisation starting to gain traction.
The paper points to the impact of measures in the Union Budget to curb the parallel economy, and the expected buoyancy in collection of direct taxes as per the budget estimates manifesting in greater formalisation of the economy. The measures announced in the Union Budget 2017-18 for the infrastructure sector, MSMEs, low cost housing and agriculture are expected to strengthen the recovery.
Guesstimates
The numbers, as put out by the RBI paper, support the government’s own calculations of an upturn in growth in 2017-18. Taking into account the likely drivers of growth, and the baseline assumptions of a normal monsoon and the budgeted fiscal deficit of 3.2 per cent of GDP, GVA growth is projected to strengthen to 7.4 per cent in 2017-18. The GDP estimates are revised substantially, thus questioning the very validity of such numbers, especially in an abnormal period. For instance, the Q1 and Q2 growth numbers for 2016-17 have been revised down, primarily on account of significant upward revision in growth numbers for the corresponding quarters of last year. More importantly, the true impact of the demonetisation on per capita GDP may not be captured by the official statistics. Nor does the restoration of the macroeconomic indicators capture the position regarding the stated reasons for demonetisation, viz. the reduction in black money and corruption.
The implicit assumption in the RBI paper is that the short-term impacts of demonetisation are over. It remains to be seen what the medium and long-term hold for India.
The author is Professor of Economics at S.P. Jain Institute of Management & Research, Mumbai. Views are personal.
