Modi govt in firefighting mode over slowdown, but where is economy heading?

Yashwant Sinha's critique of the manner in which the Narendra Modi government has dented India's economy has sparked off a debate

Former finance minister and Bharatiya Janata Party (BJP) leader Yashwant Sinha's recent criticism of the manner in which the Narendra Modi government, particularly Finance Minister Arun Jaitley, has mismanaged India's economy has set off a flurry of reactions from the administration, which is looking to counter any talk of economic failure on its part. Meanwhile, the Opposition has taken the opportunity to launch a fusillade at the Modi sarkar. (Read how Sinha ripped into the govt's economic performance)

Economic growth plunged to 5.7 per cent in April-June of the current financial year (FY18), the lowest in the three-year rule of the Modi government so far, thanks to demonetisation and destocking by companies amid jitters before the launch of the goods and services tax (GST) regime. (Read more)

With this, India lagged China in terms of gross domestic product (GDP) growth for a second consecutive quarter. The Chinese economy expanded 6.9 per cent in each quarter. 

Rejecting Sinha's criticism, the government insisted that the Indian economy was the fastest-growing in the world and some "uncertainty" was bound to occur when "transformative" measures like demonetisation and the GST were taken. (Read more)

However, statements and claims aside, where is the economy heading and have the negative effects of GST and demonetisation faded yet? 

FY18 growth forecast between 6.7% and 7%

India Ratings has lowered the growth forecast for the current financial year to 6.7 per cent, from 7.4 per cent estimated earlier, citing 'disruption in the economy' on account of demonetisation and the implementation of the GST. (Read more)

The Asian Development Bank has downgraded India's growth projection to seven per cent for the current financial year, while lowering its forecast for the next financial year as well. (Read more) 

"India's GDP growth is downgraded to seven per cent in financial year 2017-18, a 0.4 percentage point drop from the April forecast. In financial year 2018-19, the forecast is adjusted down to 7.4 per cent, from 7.6 per cent," ADB said in its Asian Development Outlook 2017 update.

GST could make things worse in the second half

"Given the scale of the mismanagement of GST", M K Venu wrote in a piece on The Wire that he would not be surprised if GDP growth in the second half of 2017 went down even further from the 5.7 per cent recorded in April-June. (Read more on how the GST could bring down growth further in the short-term)

According to Venu's article, trading companies were de-stocking before the start of the GST regime on July 1, 2017, in the hope that they would buy fresh stocks under the new tax system. But given the messy implementation, analysts say the re-stocking process is quite slow and firms would rather wait for the GST system to stabilise before going full swing again. And, all this is happening just before the festive season, so it is bound to impact GDP growth in the second half of 2017. 

To add to Finance Minister Arun Jaitley’s worries, the suboptimal working of the GST network (GSTN) has created a major risk of a revenue shortfall in 2017-18, putting the Centre’s fiscal arithmetic at risk. The finance ministry got its first shock when the GST refund applications (those seeking refunds after paying tax) totalled Rs 65,000 crore for July, when total collections were Rs 95,000 crore.

Demonetisation to blame?

Demonetisation affected the country's growth rate negatively, causing a dip to 5.7 per cent in the first quarter of 2017-18, while the GST did not have much role in the decline, economist Surjit Bhalla said recently. (Read more)

Bhalla has been chosen as a part-time member of the Economic Advisory Council to the Prime Minister (EAC-PM) constituted on September 25 to analyse economic issues and advise Narendra Modi on them.

"Demonetisation did have a negative effect. According to me, it may have contributed to 0.4 percentage decline. But GST, may be, caused only 0.1 per cent decline," Bhalla told BTVi in an interview.

Referring to demonetisation in a statement on its growth forecast on Wednesday, ratings agency Ind-Ra said: "Sucking out high-denomination currency while failing to remonetise the economy quickly has in many cases proved fatal for the unorganised sector/small and medium enterprises where business transactions are heavily cash-dependent." (Read more)

Hands off the wheel?

Writing for the Business Standard, Ajay Chhibber, distinguished visiting professor, National Institute of Public Finance and Policy, argued that the Modi government benefited "from a huge terms of trade windfall from declining oil prices" and the economy recovered somewhat in the government's first two years. "GDP growth, which was at six per cent in Q3 2014-15, peaked at 9.1 per cent in Q4 2015-16. The government basked in the global adulation of declining inflation and being touted as the world’s fastest-growing economy — faster than even China," Chhibber wrote.  

(Read Ajay Chhibber's column on the three policy issues the govt needs to address to bring growth back) 

"This huge windfall of three-four per cent of the GDP, according to the International Monetary Fund (IMF), helped Modi’s economic team to ignore worrisome signs of declining private investment, and growing non-performing loans...," Chhibber said, adding, "... without any serious reforms and huge policy mistakes, the recovery spluttered to a halt and India has now seen a decline in GDP for six quarters." 

However, according to Chhibber, the decline in growth started before demonetisation was announced. He listed out three policy issues key to longer-term recovery: Issues related to inflation targeting by the Reserve Bank of India, the overvalued exchange rate, and a serious plan to resolve the twin balance-sheet problem.

Economy in a 'dense fog'?

Describing the Indian economy as being in a period of "dense fog", Credit Suisse earlier this month said structural reforms, including GST, had introduced significant uncertainties related to growth, fiscal health, inflation, currency and the banking system in the country, for the near term. (Read more)

Credit Suisse' India Equity Strategist Neelkanth Mishra said the "Indian economy is going through a period of dense fog" with uncertainty of macroeconomic variables likely to impede investment intentions and act as a drag on growth, causing downgrades to GDP as well as earnings estimates for the next financial year.

Terming the Indian economy as "a house under renovation", Mishra said, "a number of structural changes like the exodus of millions of workers away from agriculture, the introduction of GST, the Real Estate (Regulation and Development) Act and the Bankruptcy Code are breaking down vicious cycles that the economy was trapped in." He added: "However, they also introduce significant uncertainty on several macroeconomic variables in the near term: growth, fiscal health, inflation, currency, and the banking system."

Exporter woes weigh on growth

Experts say the sluggishness in exports has been one of the prime reasons for a slowdown in economic growth in the past three years. (Read more)

The share of exports in India’s GDP declined to a 14-year low during the first quarter of the current financial year (FY18). Growth in export of goods and services has remained below overall economic growth since FY15. 

Exports at constant prices were up only 1.2 per cent during the first quarter of FY18, against 5.7 per cent year-on-year (YoY) growth in GDP during the period.

In value terms, India’s exports have been stagnant at around Rs 24 lakh crore (at 2011-12 prices) in the past three years, against 24 per cent cumulative GDP growth during the period.  

The government, for its part, is mulling a dedicated fund to expedite timely refund of taxes paid on input for exports, to address liquidity woes of exporters under the new GST regime. 

(Read what the govt is doing to alleviate exporters' post-GST woes)

A corpus of Rs 20,000-30,000 crore is under consideration, to narrow the input tax credit cycle and facilitate their working capital requirements.