It Wasn’t DeMo: India’s Growth Blues Are Due To Larger Disruptions Than Just Notebandi

One of the questions we keep hearing is “when will the economy come back to normal?” The reference may be to growth rates, consumption trends, jobs, or anything else, but underlying it all is a belief that there must be some God-given normal level for anything.

During the United Progressive Alliance (UPA) period, it was presumed that 8-9 per cent gross domestic product (GDP) growth was what we should expect. And double-digit growth should be our aim. Before that, we believed that 6-7 per cent is our basic economic potential. Since the UPA happened to be at the helm when growth rates peaked due to the global buoyancy, politically it has become important for the Narendra Modi government to prove that it can also raise growth to those levels.

But when the Central Statistics Office (CSO) told us last Tuesday (28 February) that GDP growth in 2016-17 will be 7.1 per cent despite demonetisation (DeMo), the government was cock-a-hoop and the opposition was quick to suggest – along with many economists – that these numbers are somehow fudged.

Well, my advice to both sides is chill. There is no need to garland or shoot the CSO. The higher growth number does not necessarily validate DeMo. At best, we can say that DeMo was a minor disruption compared to the bigger disruptions happening around the world. As for detractors, they will get ample opportunities to pin the slowdown blame on DeMo, since 2016-17 has anyway seen a slowdown in growth relative to the year before.

The CSO’s numbers have been doubted by many people, including the Chief Economic Adviser and former RBI governor Raghuram Rajan. But having adopted the new method, there is no point saying it does not reflect underlying reality. What should be noted is the relative change in GDP numbers quarter to quarter, year to year, and not the differences with the old GDP series. When you shift from miles to kilometres in measuring distances, all the new numbers will look bigger. This simple fact has been ignored while dissing the new numbers. The slowdown in 2016-17, including the impact of DeMo, has, in fact, been captured well by the new series. GDP growth is falling from 7.9 per cent to 7.1 per cent in the current fiscal, and gross value added (GVA) from 7.8 per cent to 6.7 per cent.

GVA is converted to GDP by adding product taxes and deducting product subsidies.

What seems obvious is that there has been a general slowdown in 2016-17, and this predates DeMo. In the first three quarters of 2015-16, GVA growth was significantly higher at 7.8 per cent, 8.4 per cent and 7 per cent; this year the numbers have been lower in all three quarters, and not just the DeMo quarter – at 6.9 per cent, 6.7 per cent and 6.6 per cent.

In other words, the deceleration due to DeMo itself may be marginal, but the broader slowdown relative to the last financial year is sharper. That is what should worry the government.

Put another way, growth was being disrupted well before DeMo, and so to expect DeMo to have been the cause of this year’s slowdown is a stretch. Equally, those who are surprised that third quarter growth was not as bad as expected (especially in GDP terms, where we got the much-hoped-for 7 per cent), should be happy with the possibility that something else may go wrong in this quarter, which can then be comfortably blamed on DeMo to score a political point.

The reality is that in a world of multiple disruptions there can be no normal level of growth for anybody. Consider the disruption seen just over the last decade: the rising disruption in global trade due to protectionism; the disruption of financial markets in 2008 and the subsequent zero-cost money policies of major central banks that distorted the financial incentive structure for capital investments; the growing surfeit of both capital and labour around the globe which has been accentuated by new labour-saving technologies and automation; the disruption of labour movements by the rising scourge of terrorism; the tectonic shift in demographic trends with a slowdown in population growth in most parts of the world, et al.

As Ruchir Sharma of Morgan Stanley has noted, the world has seen a “collapse” of working age populations, “from an annual average of about 2 per cent before 2005 to an annual average post-war low of around 1 per cent this year (2016). This one percentage point drop in population growth is likely to take a roughly equal chunk out of potential economic growth, which means the world needs to reset its expectations.” Sharma notes that even in India, working age population growth is 1.5 per cent, well below the 2 per cent “average level associated with economic miracles.”

Disruption is everywhere, and with hindsight it can be said that DeMo was just our own small disruption. But here’s the point: its disruptive potential is far lower than those provided by other factors. The worst of DeMo is behind us.

One can argue that we did not need DeMo in an already disruptive world, but even this is unproven by data for who can predict the short, medium and long-term benefits or losses due to DeMo?

Now consider how we have really fared on growth, with or without reforms, over the last 30 years and see how (or whether) our fundamental economic potential has changed much when you leave out the exceptional years.

In the pre-reform years (six years from 1985-86 to 1990-91), India’s average GDP growth was 5.6 per cent.

But in the next six years after “big bang” reforms, growth rose to 5.7 per cent – hardly a great advertisement for the Narasimha Rao-Manmohan Singh reforms.

In the next seven years (1997-98 to 2003-04), which coincided with the United Front and NDA governments, growth moved up a wee bit to an average of 5.77 per cent. So, even after the reformers exited, growth remained the same.

It was during the UPA regime (2004-05 to 2013-14) that growth really shot up to an average of 7.8 per cent. (Caveat, the first eight years measure growth under the old method and the last two under the GVA method). In the last three years, which refers to the Modi period, the average (including the advance GVA estimate for 2016-17) is 7 per cent.

The above data averages show that the basic trajectory of India’s growth was probably in the 5-6 per cent range for a very long time, both pre- and post-reform. The UPA period was an aberration, and high growth was driven by extremely favourable global conditions and by harvesting the fruits of reform sown during the Atal Behari Vajpayee period. Vajpayee left the banks in a strong state, inflation at low levels, and the external front comfortable (the country reported a current account surplus – an unheard of achievement in independent India).

The growth potential of the Indian economy is probably a little higher today than it was in 1985-2004, but the UPA period was a fluke, and not the real potential. With reasonable and steady reforms, the economic potential can be taken higher than 5-6 per cent to 6-7 per cent, but we must abandon the anchoring effect of the super-high growth figures established during the UPA. Those levels cannot be sustained in today’s disruptive world, though 9-10 per cent growth is still possible in the odd year or two.

A small factoid: in 1988-89, the last year of Rajiv Gandhi’s government, growth hit double-digits (10.2 per cent – the only time in our history), and we know what happened after that. By growing on steroids during the Rajiv Gandhi years, we destroyed the normal rhythm of growth all by ourselves. Luckily, the world was not going down the tubes at that time, and after 1991, we quickly pulled ourselves back from the brink – with cash from the IMF and help from the rest of the world. UPA-2 also grew on steroids, by inflating fiscal deficits and excess subsidisation of oil, and the subsequent slowdown was like the Rajiv Gandhi gift to his successor governments.

Regardless of whether you measure GDP the old way or the new, we are still to recover fully from the self-inflicted wounds of the UPA era.

The global headwinds are not helping an early recovery. In an era of global political, social and economic disruption, to presume that we are somehow going to hit the growth jackpot is foolish. Sure, in the odd year or two we may do 8-10 per cent, but that will be on a base effect and exceptional circumstances.

The lessons for the Modi government are this:

One, keep plugging away at ease of doing business and reforming economic administration. Don’t obsess about the GDP growth rate, or celebrate some good numbers too soon.

Two, big bang and incremental growth are not opposites. When the condition is ripe, go for big bang (GST is one example); when they are not, keep pushing small doses of reform where you can.

Three, get states into the act. The centre cannot be the driving force of the economy. Reforms must touch states, and they hold the key to faster growth.

And four, forget about what is our potential rate of growth. We can only discover that by hindsight. In an unstable world, no growth outcome is likely to mirror our expectations. Economic forecasting is no better than astrology. We must negotiate growth in the fog generated by disruptive forces. This is why we got our DeMo forecasts wrong, for global disruptions are DeMo raised to the power of 10.

But if you still want a number, I would say India’s growth average will be in the 6-7 per cent range in the coming decade.