Even as it remains one of the fastest growing countries in the world, an unmistakable slowdown of economic growth has taken hold in India. While ministers in the central government emphasise the former, they are loath to admit the latter.
India’s real gross domestic product (GDP) at market prices grew, year on year, at 3.89%, 6.39%, 7.41%, 8.00%, 8.17%, 7.17% and 6.81% since 2012-13. The corresponding yearly change in the annual growth rate is 2.49%, 1.02%, 0.57%, 0.17%, -1.00%, and -0.36% since 2013-14. The slowdown of economic growth, as measured by the growth rate of real GDP, started in 2016-17.
If we instead use real gross value added at basic prices (GVABP) as the measure of aggregate economic activity, which differs from the GDP by net product taxes, we get a similar picture. The annual growth rate of real GVABP has been 6.05%, 7.15%, 8.03%, 7.88%, 6.94% and 6.63% since 2012-13. Hence, the deceleration in aggregate economic activity is visible since 2015-16, a year before that indicated by real GDP, with the growth rate changing by -0.15%, -0.95% and -0.30% over the last three years.
One can juxtapose these data on economic performance with forecasts coming from a wide range of sources. According to the Reserve Bank of India, the International Monetary Fund, the World Bank, and a host of other private agencies, the growth rate of India’s output is expected to slow down further in 2019-20. Taken together, all this information makes it almost impossible to deny that India’s economy has entered a deceleration mode.
The current deceleration in India’s economic growth is unprecedented in terms of its duration. In the last 20 years, the growth rate of GDP or GVABP has never declined continuously for more than two years. The only time the annual growth rate of both the GDP and GVABP had fallen for two years in a row was in 2011-12 and 2012-13, but both growth rates had recovered sharply thereafter.
The continuous decline in growth rates translates into large potential losses of output and income. If it had grown between 2016-17 and 2018-19 at the same rate as it grew in the previous four years, real GVABP and real GDP would have been 0.93% and 0.54% higher, respectively, in 2018-19. If the corresponding counterfactual growth rates were the actual mean growth rates of the past twelve years, then real GVABP and real GDP would have been about 1.75% and 1.11% higher, respectively, in 2018-19 than their actual values.
The timing of the deceleration suggests an explanation of its causes – a combination of four negative shocks. Two of these shocks are policy-induced, a third is the result of slow changes in policy to rapid changes, and the fourth is of external origin – largely outside the control of domestic policy actors.
The first negative shock was generated by demonetisation in November 2016. The sudden policy move to ban high denomination currency, which comprised 86% of all currency in circulation, had a large negative impact on the level of economic activity. A recent study by Gita Gopinath and co-authors find that the cumulative impact of demonetisation led to a contraction in bank credit and output by two percentage points each. They also find that the negative shock works itself out in a few months.
By the time the economy had emerged, if at all, from the negative shock of demonetisation, the government introduced another policy that was to have an even bigger impact–the goods and services tax (GST). The GST – the second negative shock – came into effect in July 2017, and according to many commentators, policy-makers and economists, had a massive negative impact on the level of economic activity. The negative impact does not only arise due to problems of implementation, but comes from structural reasons related to its negative impact on the informal sector, as has been argued persuasively by Arun Kumar.
The third shock emanates from the financial system. Since the early part of this decade, the shadow banking sector, which is a part of the financial system that is effectively outside the regulatory purview of the monetary authorities, has been growing rapidly. This growth was the result of the longstanding problem of NPAs in the formal banking sector, which slowed down credit growth from the formal financial sector.
The growth of shadow banking sector helped in fuelling some of the credit-financed consumption expenditure that shored up growth over the past few years. But its operation also increased the financial fragility of the system, due to the inherent maturity mismatch of its assets and liabilities. The deep problems of the shadow banking sector came to the fore with the ILF&S crisis in September 2018.
The crisis in this sector continues, as the problems in DHFL in 2019 highlight, and has resulted in generating the third negative shock: a sharp contraction in credit growth. This has translated into a cutback in consumption expenditure, which has now shown up as a severe slowdown in the automobiles, real estate, cement, and other related sectors.
The final shock comes from the slowdown in the global economy. Growth has been tepid in the global economy since 2012. This has reduced the contribution of the external sector to India’s real GDP growth since 2014-15, and turned it negative in 2017-18. While the negative contribution of net exports, i.e. exports less imports, since 2017-18 is clearly a causal factor behind the current deceleration, it is important not to overemphasize the external shock.
India’s growth process has largely relied on internal sources of demand. In the past 20 years, net exports has contributed negatively to growth in 11 years. In the years of roaring growth between 2003-04 and 2007-07, the contribution of net exports was mostly negative. But growth in internal sources of demand managed to counteract the negative impacts coming from the external economy.
To counteract the current deceleration, therefore, policy-makers need to boost domestic demand in the short-run and reverse the investment decline in the medium run. A combination of three policy moves can form part of an effective strategy to combat the deceleration. Increasing wages in MGNREGA, which would increase rural demand; increasing the disbursal for food subsidy, which would make room in the budgets of poor households for non-food expenditure and address India’s abysmal record on the hunger index; and boosting public investment, especially in agriculture and infrastructure, which would kickstart the investment cycle and ease supply constraints. These are much more effective methods of increasing demand than reducing tax rates on corporate income.
Deepankar Basu is associate professor of Economics at the University of Massachusetts Amherst. He thanks Amit Bhaduri and Debarshi Das for helpful comments. (The views expressed are personal )
