The most charitable way to describe the recent shock of demonetisation, followed by a rushed implementation of GST, is to discount it as creative chaos. It is to resign to the fact that in a country like India it will probably be impossible to stage-manage any policy to execution perfection; so instead simply shock the system, and see how it readjusts itself to the new normal. It also reveals an interesting pattern in the socio-political contract that exists between the Indian public and the government; wherein the former has relatively docilely accepted the radical disruptions to their day to day life by the latter.
We may or may not eventually live in an India where black money is no longer a norm. Similarly one can only hope that some day GST will reach a level of maturity where it lives up to its promise of a simple, comprehensive tax that eases doing business. However there is little debate among economists that the double policy whammy has profoundly impacted the economy over the past one year. The World Bank, IMF, ADB and OECD have all downgraded India’s growth forecast this year, in an otherwise cheerful outlook for the global economy.
India’s economic growth is balanced on broadly three pillars – consumption, investment and net exports (exports minus imports). And a supporting structure of government spending. Pre-demonetisation, two of the three key pillars were already vacillating. Investments were down to multi-year lows on the back of poor business sentiment and a hopelessly out of breath banking sector. And Indian exports were struggling to capitalise on an otherwise improving global climate, while imports growth remained stubbornly strong.
The sole torchbearer of growth was consumption. Demonetisation attacked this pillar on two fronts – on the demand side it forced consumers to rethink participating in India’s large cash-reliant informal markets. On the flip side, it also disrupted supply chains of informal India.
Then came GST and India’s beleaguered MSMEs that were barely recovering from the twin loss of their customers and suppliers were now being yanked further into a formal economy where the rules seemed incomprehensible and costs seemed higher. Even the formal sector responded to GST with widespread destocking. Meanwhile the vitiated business environment had investments sinking to record low growth rates.
Circa a year later, luckily some revival is on the horizon. Corporate performance is seen picking up in a fraction of sectors although broadly Indian industry still remains overwhelmingly in the red in terms of net sales and operating margins. Business sentiment indicators are registering an uptick, while industrial production data is still ambiguous on the recovery. Near normal monsoons, the 7th Pay Commission bonanza and pickup of wages in the agriculture sector have provided a cushion of sorts for consumption.
In money markets demonetisation caused a sharp decline in credit growth matched by a sharp uptick of deposit growth. Businesses weren’t borrowing, and households were busy depositing their cash. This meant that the banking sector suddenly found itself flush with cash; and ever since banks have been parking this money in government securities, and idly trading among one another – a phenomenon that can be roughly described as ‘liquidity surplus’.
This complicates monetary policy transmission and the RBI has been in a huff trying to find innovative ways of draining this liquidity. To some extent, the problem is self-solving itself with credit growth picking up, albeit gradually. Meanwhile mutual funds are raking record high assets under management owing to the demonetisation-led ‘financialisation’ of the economy.
However a key thing to remember is that growth was slowing down before demonetisation and GST came to fore. In happier days, a couple of years back, the crash in global crude oil prices helped growth to the extent of even nullifying the effect of drought. The reversal of the oil price windfall, combined with increased activism on dealing with non-performing assets placed brakes on the growth momentum. Subtracting further from GDP, has been the surge in non-oil, non-gold imports. It seems anomalous given that growth slowdown generally reduces import demand – suggesting more structural changes afoot. While the negative impacts of demonetisation and GST are ebbing, these dark clouds are still firmly entrenched.
There is a saying in economics that in the long run, we are all dead. But as these policies go on to show – the short run also comes with near-death experiences!