Don’t Blame Note Ban and GST, It’s a Six-Year Structural Slowdown

When the government recently hinted at a fiscal package to revive the economy, it was countered with the argument that the economy had suffered supply shocks due to demonetisation and the introduction of the Goods and Services Tax, and that a demand-side solution like a fiscal stimulus was not the solution.

While the question of a fiscal stimulus offering a solution or not is a different debate, the macroeconomic data is still inconclusive on demonetisation and GST being the culprits for the ‘recent’ slowdown.

Don’t Blame Demonetisation And GST

Growth in the real gross domestic product has fallen steadily after reaching a peak in Jan-April 2016 (Q4FY16). As the author has pointed out in one of his previous article, forecasting GDP growth in India – with all the data issues – is not at all an easy task. Even the best and the brightest cannot assure accuracy. Ideally, the nominal GDP needs to be predicted first, then the forecaster needs to assume the inflation or systemic deflator, and then come up with the real GDP growth.

There has been a decline in nominal GDP growth right from 2011, across the old data series and the new one, suggesting a structural problem with India’s economic growth, which may have nothing to do with demonetisation or the launch of the GST.

Data on company earnings, bank credit growth, and money supply are all nominal. Of course, high inflation affects consumption but an exclusive focus solely on real GDP growth, with an exclusion of nominal GDP growth, may not give a full picture of the economy. Nominal GDP growth has been falling since 2010-11. Whether the bounceback in 2016-17 was a recovery or a blip will only be known later, but clearly, nominal growth below 13-14 percent is well below the average of the last 15 years.

With the exception of personal loans, all other sub-components of non-food credit growth have been falling since 2010-11.

Credit growth numbers post demonetisation does not, per se, suggest a structural break from this trend. In fact, March 2017 showed a moderate bounce in credit.

A ‘Normalisation’ And ‘Formalisation’ Bounce?

There is a ‘numerical’ aspect to the GDP, and there is a more structural aspect of day-to-day economic activity which no single number, including the estimated GDP, can fully capture. Bloomberg’s survey of GDP forecasts by top economists, once the new series kicked off, shows some interesting trends. The survey average undershot the actual growth in Q2FY16 by 70 basis points, and by 163 basis points in Q4FY16—the quarter that the growth peaked in. Expecting an immediate impact on growth in the quarter that demonetisation was announced, economists forecast growth in Q3FY17 to come in at 6 percent. Instead, when the first reading for the quarter was announced by the CSO, it was a shade below 7 percent! Economists hurried to revise their forecasts higher for the next two quarters, only for actual growth to miss those estimates by 100 basis points in Q4FY17 and 78 basis points in Q1FY18.

Are the downward revisions in growth estimates, that we are seeing after the 5.7 percent figure was released, again an over-compensation for having missed the inflection point in the past?

Here’s why the second half of FY18 could stump forecasters again.

• H2FY18 could well enjoy the benefit of a low base effect due to demonetisation.
• While GST did create operational issues in the inital months, especially in small businesses, those could lessen significantly in the October-March period.
• As more of the shadow economy will now be formalised under GST, economic activities which were ‘lost’ earlier for calculation purposes will now get captured.

Address The Structural Slowdown

The Indian economy can indeed do with improvement in supply chain and reducing supply-side constraints. However, to assume that the GDP growth in the last two quarters represents an incremental breakdown of supply chains usually owned by small businesses is, at least, not borne out by any publicly available data including the RBI’s credit data. The deductive reasoning mentioned earlier – as opposed to anything more mathematically robust – could suggest a temporary bounceback in GDP growth in H2FY18. However, this will not solve the fundamental issue of a slowing economy, where the unacknowledged slowdown started way back in 2011. The fiscal and monetary policy, which almost exclusively focusses on inflation-adjusted or real GDP, often underestimates the extent of this slowdown. Readings of 5-6 percent real GDP growth diminish the urgency of government action.

(Deep Narayan Mukherjee is a financial services professional and visiting faculty of finance at IIM Calcutta.)

(This Article was first published on BloombergQuint. The views expressed are the author’s own. The Quint neither endorses nor is responsible for the same.)