Arvind Subramanian, India’s chief economic adviser, points out in the Economic Survey tabled in Parliament on Monday that over 2016 and 2017, India’s trajectory “decoupled” from global economic conditions. While the rest of the world saw an acceleration in GDP growth rates, India slowed down taking it on a unique path and making it harder for Subramanian to offer up reliable predictions for 2018-19. This also has a bearing on how the government, under Prime Minister Narendra Modi, finds itself in a place where it needs to revive animal spirits in the year leading up to a general election.

Subramanian offers four reasons for why this has happened:

  1. Monetary conditions:
    In the report, Subramanian points out that until the middle of 2016, real policy rates – which is the actual rate at which lending happens, calculated by taking nominal interest rates and subtracting inflation – was falling in India along with global trends. But in 2016, while real rates were dropping in the US, in India they went up, leading to tighter monetary conditions. This led to lower consumption numbers and made the rupee stronger, which affected exports.
  2. Demonetisation and GST:
    Subramanian explains how demonetisation delivered a shock to the economy, reducing demand and hampering production especially in the informal sector. According to him, the shock had largedly faded away by mid-2017, only for the government’s roll out of the Goods and Services Tax to hit the economy, “affecting supply chains, especially those in which small traders (who found it difficult to comply with the paperwork demands) were suppliers of intermediates to larger manufacturing companies.” This led to what Subramanian calls a competitiveness impact, with India’s exports dropping steeply and imports jumping sharply, an outcome not reflected in any other Asian emerging economy or the world as a whole.
  3. Twin balance-sheet problem:
    Subramanian has been talking about the twin balance-sheet problem for some time now. This refers to the over-indebtedness in the corporate sector, which makes it hard for firms to borrow and, as a result invest, and a huge number of non-performing and stressed assets held by the public sector banks, hampering their ability to lend. “This has been a drag for some time and its effects have cumulated as the non-performing assets have increased, the financial situation of stressed firms and banks have steadily worsened,” the survey said.
  4. Oil prices
    Subramanian admitted in his press conference after the survey was tabled that he and his team got their predictions for oil prices wrong, expecting them to remain under $60 at the most. Instead they have gone past that number and the positive effects of low oil prices from previous years turned into an economic shock when they went up. “It is estimated that a $10 per barrel increase in the price of oil reduces growth by 0.2%-0.3% points, increases WPI [Wholesale Price Index] inflation by about 1.7% points and worsens the CAD by about $9-10 billion dollars.”

That last point is indeed a factor of global conditions that the Indian government would not be able to control, but it has been said for quite some time now that prices were unlikely to remain at the levels they had been when Modi came to power. Monetary policy, similarly, is not in the government’s hands entirely, although the monetary policy committee, which does feature three government nominees on the six-person panel, also makes its decisions based on the state of the economy.

Which brings us to Goods and Services Tax and demonetisation. As we have learnt, demonetisation did not lead to a windfall in black money seizures and the survey also reveals that it did not add a large number of taxpayers to the net either. The effects of the note ban, and the roll out of GST afterwards, led to the conditions that also saw tight monetary policy and so it seems safe to say that the Modi government’s two major efforts not only acted as a shock to the system, they pulled India off track at a time when global conditions were favourable.

Subramanian draws a number of lessons from these indicators, one of which seems to be directly aimed at demonetisation. “While there are significant social and economic benefits to attacking corruption and weak governance, addressing those pathologies entails challenges,” he writes.

“The lesson is that policy design must minimize these costs wherever possible. More specifically, there should be: greater reliance on using incentives and carrots than on sticks; greater focus on addressing the flow problem (the policy environment that incentivizes rent-seeking) than the stock problem; and more recourse to calibrated rather than blunt instruments (such as bans, quantitative restrictions, stock limits, and closing down of markets, including futures markets).” 

Fortunately, Subramanian’s outlook seems to suggest that India has weathered the storm created by “blunt instruments” saying that many indicators suggest a “robust recovery is taking hold” even as he acknowledges that their level remains below potential.

“If macro-economic stability is kept under control, the ongoing reforms are stabilized, and the world economy remains buoyant as today, growth could start recovering towards its medium term economic potential of at least 8 percent,” the survey said.