Economy

Time To Get The Analysis Right: Demonetisation And GST Are Not The Reasons For The Slowdown

The reason for the slowdown is most likely interest rates.   
Snapshot
  • While many are quick to point to a slowdown after the GDP figures for the first quarter of 2019 emerged, they have failed to study the figures of the previous quarter.

    In fact, the trend began since Q2 of 2018-19, but this was missed by critics, thus showing a disturbing lack of sound data-backed analysis.

On 30 August 2019, somehow, everyone started to believe in the official statistics when the Gross Domestic Product (GDP) growth rate for the first quarter of FY 2019-20 was at 5 per cent. People had hailed it as a sign of an economic slowdown and most analysts ignored that the slowdown didn’t start from the previous quarter.

The fact that official statistics have showed this since Q2 of FY 2018-19, was missed, revealing a disturbing lack of sound data-backed analysis.

On top of it, many criticisms of the GDP series were levelled, such as ‘growth didn’t feel good’ – and this was well reflected in official statistics. Yet, many were oblivious to what would have been obvious in other nations.

Since then, we’ve seen some analysts continue to question the GDP numbers, not realising that the low level of nominal and real growth further shows that, perhaps, our official statistics are at least as good (or as bad) as they were before.

Recently, some professional pessimists were even surprised at the assertion that a major reason behind the revenue shortfall was the slowdown in nominal growth rates.

Many like them have often argued that the present slowdown is structural in nature – and consequently, they’ve asked for structural reforms.

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However, the figure of 5 per cent should settle this debate as it shows how a major component of the slowdown must be cyclical, given the low level of growth.

It is conventional wisdom that tax revenue is a function of tax rates, tax compliance and economic activity. Therefore, one shouldn’t question that the low growth in taxes is largely because of relatively low levels of economic growth.

It is apparent from Figure 1 where we have the growth rate of gross GST collections and Nominal GDP.

It makes it obvious that the recent slide in growth rate has had an impact on indirect tax mobilisation. This should be intuitive but for some reason it came as a surprise for some analysts.

Figure 1: Growth Rate of Nominal GDP, Total GST collections and CGST Collections.

Nominal GDP and tax collections Nominal GDP and tax collections

The other assertion is to do with the causes behind the current slowdown. Many have attributed the current slowdown to the combination of demonetisation and the implementation of Goods and Service Tax.

In fact, India’s former Prime Minister, Dr Manmohan Singh – who also happens to be an economist – had termed them as a ‘monumental disaster’.

He had claimed back then that GDP would be lower by 2 per cent because of demonetisation. The annual growth rate didn’t witness a 2 per cent decline, but there was a temporary decline in growth followed by a sharp recovery.

GDP at market prices — 2014-2019.  GDP at market prices — 2014-2019. 

It is interesting to note that growth was on a downward trajectory from the second quarter of 2016 and therefore, the extent of impact that demonetisation would have had on our growth is only likely to be lower than what was anticipated (To read more on demonetisation’s impact on the Indian economy, please refer to a joint paper with Dr Srinivas Thiruvadanthai by clicking here.)

The other assessment is to do with the impact of GST on India’s growth rates. For starters, when we look at the total GST collections or the CGST collection, we find that tax collections have increased except for in the second quarter of 2018 when it witnessed a dip.

Since then, the tax revenue has witnessed a continuous increase although the rate of growth has slowed due to an overall slowdown in the economy.

The GST came into effect in August of 2017, which would be the second quarter of 2017. The recent slowdown started from the second quarter of 2018-19.

Therefore, it is highly unlikely that GST would have had a structural impact on our growth. Indeed, one acknowledges that in many industries, the transition to GST has caused problems and that teething troubles were there during its implementation.

But, in a country as big as India, such teething troubles are bound to be there when there’s a complete overhaul of the indirect taxation system.

The fact that despite the teething troubles and frequent changes in items in different GST slabs, our growth rate was decent further strengthens my argument.

So, if GST and demonetisation didn’t impact our growth rates, then what did? It’s the real interest rates and the MPC.

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Regular readers are aware of my obsession with fixing our monetary policy because it is largely responsible for the current deceleration of our growth rates.

But we didn’t hear a word from Dr Singh on the MPC’s misguided monetary policies, while our professional pessimists have often ignored the decisions taken by the RBI.

The correct prognosis of the problem is important to find policy interventions that can recover our growth rates.

Unfortunately, many analysts are sadists as they rejoiced when the figure of 5 per cent was published as it gave them an opportunity to criticise Prime Minister Modi.

Interestingly, these are the same people who believe that reforms and only reforms are likely to help revive the economy as this is a structural slowdown. But then again, if they got the diagnosis wrong – how can they get the prescription right?

Reforms and counter-cyclical policies are not in conflict with one another and neither are they substitutes.

They’re complimentary and while nobody is saying that reforms aren’t important, but fact remains that the economy needs aggressive tax cuts and aggressive rate cuts. Those who argue otherwise must be ignored.

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