The economy is in a trough. The first quarter of 2017-2018 saw the growth of gross domestic product (the total value of all goods and services produced in a country in a year) drop to 5.7% from 7.9% in the corresponding period last year – the lowest rate in the three years the Bharatiya Janata Party-led government has been in power. The Index of Industrial Production for July released on Tuesday came in at 1.2%, after contracting 0.2% in June, showing that manufacturing has not picked up. On the same day, the Consumer Price Index showed that the inflation rate had risen to a five-month high of 3.4%.

Finance Minister Arun Jaitley acknowledged that the GDP numbers for the April-July quarter were of concern. But then, BJP president Amit Shah told businessmen that the slowdown in the economy was due to “technical reasons”.

Are these numbers an early warning of possible stagflation with low demand, high unemployment, decline in GDP and persistently high prices? What will it take for the economy to be nursed back to health?

Himanshu, an associate professor in economics at Delhi’s Jawaharlal Nehru University, believes the breakdown in the economy is neither a result of one-off events such as demonetisation, nor a technical problem. In an interview to, he listed the reasons for the collapse of domestic demand and the economic crisis India is facing. He also explained why the government has limited room to manoeuvre and bring the economy back on track.

Professor Himanshu.

Where do you see a revival in the economy taking place?
The Reserve Bank of India has confirmed what all of us knew. Demonetisation caused much pain without any gain. What kind, what level of pain and where it was inflicted are still playing out. We have witnessed some of the negative effects of demonetisation on the economy. But demonetisation was not the trigger for the economic collapse one is witnessing today.

You call it a collapse?
Yes. I would go as far as that. It is a kind of collapse, yes. The data is clear on this. Since 2015-2016, growth rates have been going down. It is not as if the 5.7% growth rate for this quarter has come about suddenly. These numbers represent a very serious set of problems with the economy. And, those problems have been neglected for a long period of time, which is why they have come to bite us today.

What are these problems you refer to?
Some of these problems started in 2013-2014. Wages had started turning negative in real terms since 2013. The problem of non-performing assets had appeared by then. The global recession was visible. These factors were well-known. The one big trigger that happened around the time the present government took over was in August 2014, when primary commodity prices collapsed following a fall in oil prices. This hit farmer incomes hard.

Then we suffered consecutive years of drought in 2014 and 2015. This was only the third time since Independence that we had back-to-back droughts. And, these were difficult to deal with for any government. In 2014, agriculture GDP contracted and in 2015, it was almost flat. These factors severely dented agricultural incomes. Since wages were anyway going down, rural demand collapsed by 2015.

Obviously, jobs were not being created and wages were turning negative in real terms – growing slower than the rate of inflation.

The government should have taken note of the severe depression in rural demand that was prevalent for a long time. The impact eventually spilled over to other sectors. Exports had been falling for two years and the government, again, ignored the trouble spots and went about as if nothing had happened. Private investment has slowed down and credit growth is at its lowest.

Back-to-back droughts in 2014 and 2015 severely impacted the agricultural sector. (Credit: AFP)

Explain the spillover please.
The impact on the construction sector became visible with construction GDP turning negative in the last quarter and manufacturing starting to decline. Credit declined and private investment went down. This happened over two years. Construction is key to employment creation. It has been the bulwark of employment in the non-agricultural sector in the past 10 years. But the government was in denial till the second volume of the Economic Survey came out and the chief economic advisor, for the first time, accepted the possibility of demand deflation in the economy. He was quite forthright. But, this admission should have come earlier, should have been flagged earlier.

Instead, in a normal monsoon year in 2016 after two consecutive droughts, when the situation was improving, demonetisation broke the back of the informal economy. It acted almost like a drought does on the economy. And the non-agricultural sector that usually acts like a sponge, failed to do so. Demonetisation delayed hopes for the revival of the economy, and demand deflation was extended.

What data do we have to understand the impact of GST on the informal sector?
Since it has only been a month or two since the Goods and Services Tax (a single nationwide tax replacing all state and Central levies that came into effect on July 1) has been implemented, we do not have data to assess and quantify its impact on the informal sector. The first-quarter numbers show a pre-GST spike in trading compensated by the slowdown in manufacturing. Moving ahead, new data on the service Purchasing Managers’ Index suggests a slowdown, construction and manufacturing are stuck at a low, and the profit margins of the corporate sector are squeezed. One thing is sure, GST has impacted the informal sector in terms of taxes and cost of compliance, which basically means hiring consultants – and you can see that in the data too. Remember, the data that has come so far is up to June. We have not seen the GST impact as of now. If it hits the unorganised sector, then manufacturing will be in deeper trouble in the coming quarters.

Where do you see the revival?
The current scenario does not make me feel too optimistic about the next two to three quarters. Whatever little information we have at the moment, it indicates no signs of private economic activity reviving. Worse, agriculture will make a very low contribution to growth in the next quarter – this was confirmed a few days ago by the agricultural secretary – and foodgrain production will be same as last year. The hope of any increase in production is from horticulture and livestock.

But, again, the livestock sector has been hit by political considerations outside the economic arena. The limited information here today is that all this beef controversy could contract the livestock sector as well.

In agriculture, if you exclude cotton, all other major kharif (summer-sown) crops have shown a decline in acreage.

Though the average monsoon figures delude us to believe this is a normal year…
One should not go by aggregate numbers. The distribution of the monsoon is very important. The monsoon has been surplus or in excess in areas endowed with very good irrigation facilities. There, the surplus does not make a difference unless a deluge causes damage. In areas that are deficient of rain this year and also do not have irrigation capacity – the rain-fed areas – here the impact can be very bad. Say, Madhya Pradesh for example. Some places like Karnataka and Tamil Nadu are already suffering from deficient rain for the past two years. Given that agriculture is coming on a high base, it is unlikely to contribute too much to GDP in the next quarter.

What about the service sector?
What has kept the service sector safe so far is largely government services and administration along with the blip-up in trade due to pre-Goods and Services Tax de-stocking. The service Purchasing Managers’ Index for August has shown a decline. How much of an actual decline or contraction in the service sector that will convert into, one will have to watch out for. There are no visible signs of green shoots right now in the economy. The State Bank of India has already pared down the growth rate for the entire year to 6.5%. My own hunch is that the others will also revise their growth projections downwards after the second-quarter results are out. There is almost a consensus emerging that the mess in the economy is far more serious than what people had assumed earlier.

The capital investment by the government has been the saving grace so far though…
Yes. But again, there are two factors. And, one of these has been pointed out very clearly in the Economic Survey Volume II. Farm loan waivers by nine states have sucked up the resources of state governments – there is a decline in capital formation in the states. That is telling us that state government expenditure towards investment is going down. The spending capacity of states has been squeezed quite dramatically and total fiscal deficit (the difference between total revenue and total expenditure) of states has increased. This will have an impact on the government’s ability to ramp up expenditure in the coming months to revive demand. Remember, by the end of June, the Central government had already reached 92.4% of its fiscal space. So, there is not much manoeuvring room left for either the state or the Centre.

Finance Minister Arun Jaitley has conceded that the 5.7% GDP growth rate in the first quarter is a matter of concern. (Credit: Jim Watson / AFP)

So you think the government now needs to breach the fiscal deficit target to revive demand?
Yes, it will have to. The government is hoping to collect more from non-tax revenue sources. It had a lot of hope for one source initially – dividend from the Reserve Bank of India – but that hope has been dashed. Two other sources the government is banking on are telecom auctions and disinvestment of public-sector undertakings. Both depend a lot on market conditions. Even though it has floated the idea of selling off Air India, I do not think this is going to materialise soon. Given the market situation and the heavy squeeze on the telecom sector caused by the launch of Reliance Jio – a war that is still continuing – these decisions could get delayed.

There was an economic slowdown during the previous National Democratic Alliance government and then in 2008 the global economic crisis impacted India as well. How was it handled at that time?
This is similar to what happened during the time of the Atal Behari Vajpayee government (1998-2004). There are a number of parallels in that sense. At that time, too, the government failed to recognise that there were problems. To some extent, the “India Shining” slogan came out of not recognising the economic situation. Inflation was low, wage rate growth was low, agriculture had almost collapsed. Foodgrain production on per capita basis had turned negative. This is true with this government also. If you look at foodgrain production numbers, it was 265 million tonnes in 2013-2014 and it has been projected up to 276 million tonnes for this year. So in four years, it has gone up by just 10 million tonnes, the lowest in the last 15-20 years. This is lower than the rate of growth of the population. In terms of per capita, that means foodgrain growth is negative. Incomes are negative in real terms. Agricultural investment is negative. This is similar to the National Democratic Alliance government period.

But 2008 was different because the problems that hit our shores spiralled out of a global crisis. But by then the domestic economy had recovered. We had one of the best runs of growth between 2004 and 2008, aided by various factors. The government distributed a lot, it earned a lot. The agriculture sector was clocking around 4% growth. Incomes were rising. Global commodity prices were rising, so terms of trade shifted in favour of the agricultural sector and farmers benefitted. Construction and manufacturing were growing at their fastest rates. That gave us the cushion to go in for a fiscal stimulus and revive demand. To top it, we were not so directly exposed to the financial crisis in developed economies and domestic demand was the prime driver. Right now, the engine of the economy – domestic demand – has collapsed.

So what are the options before the government right now, remembering that the next Budget is a politically crucial one before the 2019 general elections?
Yes, 2018 will be the last serious Budget the government will be presenting. In 2019, it would be a vote-on-account more or less. I say this very seriously: the first thing is to acknowledge the gravity of the problem. The government has played blind for long to what has been happening in the economy. I think now there may be some recognition because the numbers are pretty much in your face. It is difficult to brush them aside. The finance minister has come on record to say that these are of concern. That is the first time the government has acknowledged such concerns. But I am not sure if they actually have a very good idea of the magnitude of the problem. Right now the engine of the Indian economy, domestic demand, has collapsed.

Last year, private consumption expenditure was quite high and driving the economy…
That is a funny thing. It is there in the data. If you look at the share of private final consumption expenditure as a share of gross domestic product, it was roughly 62% during the third quarter (October-December) of 2016-2017 – this is the festive season, so private consumption is usually high. Then, mid-way through this quarter, demonetisation happened and sucked out buying power. Compared to the third quarter of 2016-2017 with severe disruption in its second half, the share of private final consumption expenditure in gross domestic product has come down now. in the last quarter, it was down to 57%. That should be a worrying sign.

Why do you think the government has been unable to respond more efficiently to the situation that you call an economic collapse?
There have been just too many disruptions in the economy at the same time. What is needed is somebody who can work hands on with the economy.

You are referring to the finance minister?
I am talking about the entire economic policy-making group. I am including the Reserve Bank of India in it. The previous government had a large number of people advising it on economic policy, such as the economic advisory council – a number of economists were on board. You had the Planning Commission that was bringing out regular reports as well. The policy-making is never one individual, it is a collective effort. Unfortunately, here, the government’s ability to tap into a pool of economists and experts is very limited. Niti Aayog is in transition now and earlier, it was not on good terms with one arm of the ruling dispensation – the Rashtriya Swayamsevak Sangh, which is the BJP’s ideological parent. The Reserve Bank is already under fire, the chief economic advisor, too, may change now, I hear. There needs to be a point where experts, economists and policy-makers come together.

But there used to be friction among these experts in the previous government. Within the Planning Commission, between the Planning Commission and the National Advisory Council, and then with the chief economic advisor...
Those differences are bound to be there. No two economists are going to have the same opinion but there was broad consensus earlier on what was the problem with the economy at various stages. I think this government has far less differences than the previous one and that probably is its problem. I would suggest that somehow the government seize the moment and act fast. If this continues for long, it will take a disproportionately greater effort to recover to what is now considered a normal 7% growth rate.