The deceleration in GDP growth which commenced in the second quarter of the last financial year [FY] has continued during the current year even as the growth during the first quarter ending June 30, 2019 has plummeted to a record low of 5%. Moreover, there appears to be no sign of reversal even as the Reserve Bank of India [RBI] – in its latest [October 4, 2019] monetary policy review – has projected growth of just 6% for 2019-20 – down from its previous estimate [August, 2019 policy review] of 6.9% .
Analysts have propounded several theories from purely cyclical to decline being of a ‘structural’ nature to doomsayers predicting that Indian economy is heading for a prolonged recession. The political parties even argue that this is the inevitable outcome of what they allege as two major blunders committed by Modi – government viz. demonetization [November 8, 2016] and badly planned launch of the Goods and Services Tax [GST].
They aver that these two steps have led to large-scale closure of industries particularly in the small-scale sector causing job loss and reduction in income which in turn, has taken a toll on growth. This line of argument might be relevant to explain slide in growth in the immediate aftermath of implementing these reforms.
The demonetization instantaneously sucked out 86% of the currency in circulation embedded in the banned 1000 and 500 rupee notes thereby affecting industries and businesses which were run predominantly on cash. Besides, farmers who conduct their sale and purchase on cash basis were also affected. Likewise, GST could be disruptive in the near term as small businesses needed time to adjust to the new regime. Yet, the outcome was not terribly worrisome. During 2016-17 and 2017-18, the GDP growth was 8.2% and 7.2% respectively.
However, the trend during 2018-19 was anomalous as contrary to expected recovery [as currency was fully replaced and GST stabilized], growth slipped to 6.8% caused largely by sharp deceleration during the third quarter to 6.6% and further to 5.8% during fourth quarter. The data released by the National Account Statistics [NAS] should help in demystifying the anomaly.
During 2011-12 to 2015-16, the proportion of households gross financial savings kept in the form of cash was in the range of 8.4% to 13.4%. This share went down from 13.4% during 2105-16 to minus 22% during 2016-17 [the year when demonetization was announced] – a decline of 35.4%. The proportion of deposits during 2011-12 to 2015-16 was in the 43.1% to 57.9% range. This share jumped from 43.1% during 2015-16 to 67.3% during 2016-17 – increase of 24.2%.
However, during 2017-18, there was an equally dramatic reversal. The share of cash in household savings increased from minus 22% during 2016-17 to plus 25.2% during 2017-18 – an unprecedented swing of 47.2%. The share of deposits declined from 67.3% during 2016-17 to 28.6% during 2017-18 – a huge decline of 38.7%.
When, taken as a percentage of value of bank notes in circulation, the cash with the public was in the range of 7.7% to 12.2% during 2011-12 to 2015-16. This turned negative 24% during 2016-17. However, during 2017-18, it increased to 26% – a swing of 50%.
Prior to 2016-17, households held a significant amount of their savings as cash. This included a big slice of ‘unaccounted’ cash. The demonetization forced hoarders to deposit it in banks or convert into other forms such as gold, real estate etc. As a result, there was steep decline in their holding in cash [even turning negative] and corresponding increase in the share of deposit.
The huge amount of cash coming to banks and concomitant surge in tax collection [an inevitable outcome of hoarders being forced to file income tax return and pay tax] helped the government spend more on infrastructure and welfare schemes on one hand and banks lend more money to industries and businesses on the other [success of MUDRA (Micro Units Development & Refinance Agency) scheme owes a lot to increase in cash with banks]. Indeed, this helped in achieving reasonable growth during 2016-17.
However, rebound of cash to 25% of household savings [almost double the level it was prior to demonetization] within just one year is very disturbing. Correspondingly, the steep decline in share of deposits to 28% [a level significantly less than it was before 2016-17] is equally disturbing. It also points towards the possibility of people accumulating ‘unaccounted’ cash and avoiding payment of tax.
It is also possible that a good slice of the ‘unaccounted’ money that was deposited by hoarders during November 9 – December 31, 2016 was withdrawn by them [albeit as new currency]. Put simply, black money was converted to white. The ex-finance minister, Arun Jaitely used to say ‘merely because black cash is deposited in bank, it does not automatically become white; it gets an address enabling agencies to chase it, collect tax and levy penalty’. The agencies have not delivered what they were expected to.
When, people are sitting over mountain of cash, there is little one can expect by way of boosting demand. Further, steep decline in deposits has affected the ability of banks to lend more. The crisis in the NBFC [non-bank finance companies] sector caused in large measure by ‘fund diversion’ by unscrupulous promoters/borrowers has aggravated liquidity squeeze [e.g. IL&FS, DHFL]. Even the government is not able to sustain high spending, courtesy decline in tax collection. All this has combined to push growth in to a downward spiral.
During the last three months, Nirmala Sitharaman has come with several booster doses including a steep cut in corporate tax rate, heavy dose of capital infusion in banks etc. Yet, if we don’t see recovery, it only shows the domineering effect of things returning to ‘business as usual’. The government is contemplating more measures such as reduction in personal income tax to prop up demand. These too won’t be of much use unless this cult of ‘business as usual’is shed.
The problem is not with the policies or their implementation per se [there is nothing like an ideal policy or 100% perfect execution]. It has more to do with a deep routed cult of ‘manipulating’ the system and ‘sabotaging’ reforms. There are moles sitting in every crucial wing of our governance system viz. bureaucracy, banks, income-tax [IT] and other agencies.
How else, the banks allowed truck load of cash to be deposited with them without asking any question? How else, they allowed withdrawal of truck load of that cash as new currency? How come, the IT department and other agencies viz. Enforcement Directorate [ED], Central Bureau of Investigation [CBI] didn’t take action against all those hoarders whose cash deposits were suspicious? What happened to that infamous list of 18 lakh suspicious accounts?
With these forces at work to ‘manipulate’ the institutions and ‘game’ the system which have the inevitable effect of wealth accumulation in a few hands, there is no point cribbing about ‘demand destruction’ or ‘slowdown’ in growth. By blaming Modi and his policies [demonetization et al] for these problems, we will only be fooling ourselves.
Instead, the focus has to be on how we can strengthen the hands of Modi and his team in stemming the rot.