Don’t blame it on demonetisation | Business Standard Column–15.08.2017

India’s economic growth is faltering. Part-II of the Economic Survey, just released, thinks that growth in 2017-18 is likely to be closer to the lower end of its projection of 6.75-7.5 per cent than to the higher end.

Many commentators have a ready explanation for the worsening outlook: The disruption caused by the demonetisation of the rupee last November. They are wrong. There was little deceleration on account of demonetisation in 2016-17 and there is likely to be even less in 2017-18.

Former prime minister Manmohan Singh had said in Parliament that he expected demonetisation to impact growth by 2 per cent. GDP growth fell from 8 per cent in 2015-16 to 7.1 per cent in 2016-17, a reduction of 0.9 percentage points. Even this deceleration was not fully the work of demonetisation. In 2015-16, the price of oil had fallen sharply giving the economy a substantial consumption dividend. In 2016-17, it stayed at about the same level thus robbing the economy of the dividend.

Many analysts have said the impact of demonetisation would continue over at least two quarters in 2017-18 rendering a growth rate of 7 per cent difficult. They say that the informal sector especially will take a long time to recover from the beating it has taken from demonetisation.

Part-II of the Economic Survey makes no mention of the demonetisation impact in downgrading its forecast for 2017-18. Indeed, the Survey is of the view that since January 2017, monthly indicators such as the Index of Industrial Production and real credit growth to industry point to a bounce back. Data on two-wheeler sales suggests that the impact on the informal sector has “disappeared” since March 2017.

The Survey addresses one other problem laid at the door of demonetisation: The rise in agrarian distress. Many analysts have said that the disappearance of cash has caused prices of agricultural items to tumble and led to widespread distress among farmers. The Survey does find evidence of a fall in farm revenues for select items such as pulses and some vegetables. However, it ascribes the fall, not to demonetisaton, but to factors such an increase in supply, stock limits on wholesalers and retailers, limits on exports and liberal imports.

If GDP growth were to decelerate this year, demonetisation would not be the villain. The Survey identifies the factors that would hold back growth in 2017-18. One, the rupee has appreciated by 1.5 per cent in real terms since February 2017. Two, several states have announced farm loan waivers and many others may follow. The Survey estimates that farm loan waivers could reduce growth by as much as 0.35 per cent this year.

Three, given that inflation rate has declined to as low as 1.5 per cent, the real policy rate is higher than was assumed in Part-I of the Survey earlier in the year. Four, the problem of excess corporate debt and high non-performing assets in the banking system is now complicated by growing stress in two sectors: Power and telecom. Credit growth will remain weak as banks are unable or unwilling to lend more. Five, there are the transitional frictions that the goods and services tax would cause.

Demonetisation may not have impacted growth significantly but what has it achieved? Many analysts think it has achieved nothing other than disrupting growth — and for longer than the Survey believes. The Survey attempts an answer to the question.

Demonetisation was supposed to reduce cash transactions and increase digitalisation. This has indeed happened. Cash transactions are down by 20 per cent relative to the level that might have been expected had demonetisation not happened. Excess cash has been transferred to the banking system. Digitalisation has increased across various income categories. But a key outcome, a reduction in real estate prices due to lower use of black money, has not materialised. Real estate players will tell you that cash is alive and well.

Demonetisation was also expected to improve tax compliance and boost tax revenues. The Survey estimates that 540,000 taxpayers – about 1 per cent of the total — were added on account of demonetisation in just a few months. But the average income reported was Rs 2.7 lakh, only marginally above the tax threshold of Rs 2.5 lakh, so tax collections will not benefit much.

However, this may not be the whole story. It could also be that existing taxpayers end up declaring more than in the past. In 2016-17, tax collections rose by 23 per cent over the previous year. But this was driven mainly by the one-off Income Disclosure Scheme, which netted Rs 65,250 crore of undisclosed income.

The crucial question is whether the rise in income tax collection of 25 per cent estimated for 2017-18 will materialise. In August, advance personal income tax collections were up by 41 per cent over the previous year. This augurs well. If the projection for the year is met, demonetisation could be called a success. It would have met three key objectives while having a limited impact on growth in the short-run.