The rate at which the Indian economy grew in the first quarter of the 2017-’18 financial year is, to put it mildly, disappointing. Gross domestic product growth fell to 5.7% in April-June from 7.9% in the corresponding period last year, government data showed on Thursday. Gross domestic product is the final value of all goods and services produced in a country. For an economy long used to growth figures in the region of 8%, this came as a shock. The 5.7% growth rate is the lowest in three years.
What caused this sharp fall? Union Finance Minister Arun Jaitley pinned it on the rollout of the new Goods and Services Tax regime – a single nation-wide tax that subsumes a range of central and state taxes. “Since it was announced that GST would come into operation from July 1, most manufacturers were de-stocking during the April-June period,” he said. “As a result, trading went up because sales were taking place but it was stocks which were being sold. No new manufacturing happened.”
While this is certainly true and the rollout of the Goods and Services Tax would have disrupted the economy, is that the only reason? Did the government’s demonetisation policy have nothing to do with it? On November 8, Prime Minister Narendra Modi had announced the withdrawal of Rs 500 and Rs 1,000 bank notes as legal tender, rendering 86% of the currency in the system useless and striking a hard blow to an economy heavily reliant on cash.
In the months since, the Centre has played down the effect of the note ban. “It is incorrect to hold demonetisation responsible for the slowdown of growth in the GDP,” said the chief statistician of India, TCA Anant.
Elephant in the room
Yet, the government’s reluctance to blame demonetisation seems rather simplistic. When the policy was announced, with the objective of flushing out black money, economists the world over had criticised it, predicting that it would harm the Indian economy. This forecast came true in the fourth quarter of 2016-’17 (January-March), as GDP growth slowed to 6.1%.
This slowdown pokes holes in the government’s argument that the Goods and Services Tax is to blame for the fall in GDP growth in the first quarter of this financial year. The new tax would have had no impact on the fourth quarter of 2016-’17 and yet, growth was hit. It is quite probable that the deep impact of demonetisation spilled over into the April-June period too.
More clarity is achieved if we look at a sector-wise breakdown of growth rates, such as in real estate and construction. “The lingering impact of demonetisation is visible in the low growth of construction,” Aditi Nayar, an economist at credit rating agency ICRA, told Reuters. Construction grew at a rate of 2% in the first quarter of 2017-’18, down from 3.1% in the corresponding quarter in 2016-’17.
Similarly, manufacturing declined sharply to 1.2% from 10.7% over this period, while mining and quarrying showed a negative growth of 0.7% in April-June.
What is common to all three sectors? They are highly dependent on cash.
Meanwhile, sectors that are not as reliant on cash did not do as poorly. Financial services clocked a growth rate of 6.4% and trade, hotels, transport and communication grew 11%.
More bad times ahead?
Moreover, these numbers do not capture the one area that bore the brunt of demonetisation: India’s large informal sector, which works almost entirely on cash.
Will the situation improve from the next quarter? It might be too early to tell but there are signs pointing to a continued slowdown. The government has already reached 92% of its fiscal deficit (the difference between the government’s total revenue and its total expenditure) for 2017-’18 in its first four months, according to a report in the Economic Times. This means that while government spending boosted growth in this quarter, the lack of it will pull down growth in the upcoming quarters.
“The effects of the cash ban were likely to be felt for a few quarters,” Hugo Erken, senior economist at the Dutch financial services firm Rabobank, told the Economic Times.