Indian economy’s reality will haunt Modi
If Indian Prime Minister Narendra Modi doesn’t embrace reality, then reality will catch up with him. The tale of King Canute holds a salutary lesson to Modi.
Canute set his throne by the seashore and commanded the incoming tide to halt and not wet his feet and robes. Yet continuing to rise as usual, the tide dashed over his feet and legs without respect to his royal person. Then the king leapt backward, saying: “Let all men know how empty and worthless is the power of kings, for there is none worthy of the name, but he whom heaven, earth, and sea obey by eternal laws.” He then hung his gold crown on a crucifix, and never wore it again “to the honor of God the almighty king.”
Like the seas, national economies cannot be ordered about. Any stopping of the rising waters requires long-term and carefully constructed plans for dikes, seawalls and water concourses. This requires a time frame India’s leaders do not have the luxury of enjoying. So they create illusions that they can sell to the voting citizen consumer. The prime minister is the master of illusion.
Changed GDP gave artificial boost
One of the first economic policy decisions of the Modi government was made in January 2015, to change the base year and method of calculating gross domestic product (GDP). Not that this has not been done before, the last time being 2010. To do it so soon after suggests malice aforethought, for the change of the base year from fiscal 2004-05 to 2011-12 and switching to a market price calculation of GDP boosted its growth. Thus, during the last year of the United Progressive Alliance (UPA) government under Dr Manmohan Singh, it changed from 4.7% to 6.9%, suggesting that it was doing quite well as far as growth was concerned.
This post facto boost of 2.2 percentage points given to the UPA then began to boost GDP growth in the era of the Modi-led National Democratic Alliance (NDA) by 2.2 points as well. But even this didn’t help sustain the illusion of rapid growth that the Modi regime was trying to create.
The problem was that even this was not working and nominal GDP growth – before adjusting for inflation – was falling. It came down to 5.2%, but the Modi government got a windfall in the form of deflation of about 2.2%. So the real GDP growth became 7.4% with the 2.2-point boost. This enabled India to stake the claim of being the “fastest-growing major economy in the world.” It was just statistical legerdemain.
In the real world, nominal growth matters much more than inflation-adjusted real growth. To a firm’s revenue, whether from realizations from current sales or projections for the future, cash flows and investments, real growth hardly matters. Nominal growth matters for the government too because tax revenues also are affected by deflation. The sharp decline in direct tax collections gave this away, but Modi and Finance Minister Arun Jaitley are not ones to be bothered with such niceties and accuracy. To them it is all about creating a spin and sustaining it. This is a habit that persists.
To compound matters, falling revenues also began to impact job creation and the mood of gloom and doom began to infect the public mind again. So in November 2016 Modi reached into his bag of tricks and pulled out another bunny. He went in for a ban of 500- and 1,000-rupee banknotes.
This was not a demonetization as is commonly understood by economists. It was a straightforward, albeit somewhat draconian, note-exchange scheme. Demonetization is described as “the act of stripping a currency unit of its status as legal tender. It occurs whenever there is a change of national currency: The current form or forms of money is pulled from circulation and retired, often to be replaced with new notes or coins.”
The condition that usually forces demonetization is hyperinflation. And here India was experiencing deflation. But Narendra Modi does not burden himself with concern for terminological accuracy.
Modi stated three major objectives of this sudden and draconian announcement. The first was to force “black money” back into the formal system. The second was to filter out counterfeit notes, and the last was to cut off terrorist funding. In November 2016, 86% of India’s currency was in 500- and 1,000-rupee notes.
It was hailed by the government’s drum beaters as a stroke of Modi’s genius that would result in a bonanza of nearly 4 trillion rupees to the Reserve Bank of India (RBI). The government’s propaganda machine even showed clips of old banknotes being dumped in rivers and wells. The picture being painted was of the corrupt and tax evaders being scared out of their wits and just dumping the cash. But the people of India are made of sterner stuff and today 99.83% of the extinguished cash has come back to the RBI, and it is still counting.
But well before the notes were counted, Modi went to work demonizing critics of demonetization as supporters of tax evaders, crony capitalists, criminals, corrupt bureaucrats and sotto voce politicians. He began to shout from the Bharatiya Janata Party’s election platforms in India’s most politically significant state, Uttar Pradesh, and others where elections were due. It seemed to work, for in UP the BJP got a lopsided, even though somewhat diminished, electoral verdict. But did the net catch many counterfeits? The RBI’s answer is a firm no! Has terrorist funding ceased? The answer has to be no, as little seems to have changed.
Complicated tax regime
By taking that much money out of the market, Modi inflicted huge pain on an economy where 98% of all transactions, accounting for 68% of the value, are in cash. At any given time about 150 million workers in the informal sector are daily wage earners and are still paid in cash. The abrupt sucking out of 86% of the cash led to huge job losses, and tens of millions just went back to their villages. The economic costs have been estimated to be at least 2.25 trillion rupees (US$31 billion) or 1.5% of the GDP that year. It cost another 400 billion rupees to print new banknotes, reset automated teller machines, and transporting the cash. More than a hundred died in the waiting lines.
Now Modi’s drum beaters are back playing their usual game. In the past few weeks government spokesmen have been exulting over second-quarter GDP growth having touched 8.2%. Q2 is always the high GDP growth quarter. This is mostly because government and private expenditures are rushed through to beat the year-ending closure of the books. Q2 growth in 2015 was 8.4%. In 2016 it was 8.1%. As a matter of fact Q1 in 2016 clocked 9.1%, suggesting that India was heading north that year.
After the self-inflicted injury of demonetization, Q2 growth in 2017 plummeted to 5.6%. Now that Q2 2018 growth has clawed back to 8.2%, it just means we have resumed on the old track and that we lost a year and at least 2.25 trillion rupees on a harebrained diversion.
The other big-bang reform undertaken by Narendra Modi and announced in a dramatic midnight speech in Parliament was the goods and services tax (GST), a tax regime he was singularly opposed to as the chief minister of Gujarat state and which he thwarted. Since its launch it has been amended about 200 times.
Instead of simplicity, the new GST regime spread chaos. One thing that is commonly accepted is small businesses across the country, which together employ 110 million persons and contribute a third of the national economy, are hurting. According to estimates by the well-regarded Centre for Monitoring Indian Economy in Mumbai, nearly 5 million workers lost their jobs over the past year. India’s unemployment rate rose to 6.4% in August from 4.1% in July last year despite an additional 17 million people joining the workforce.
But the prime minister blithely keeps repeating that his MUDRA (Micro Units Development and Refinance Agency) program has created employment for as many as 7 million people in 2018. Modi says: “This data of 7 million jobs is not like building castles in the air. It has been calculated by an independent agency on the basis of the Employees Provident Fund Organization figures.”
But here is the catch. EFPO only captures data of businesses with a payroll of more than 20, which means if your payroll of 19 goes up by just one, the data captured will tell you of 20 new jobs.
India’s crises are more systemic in nature and need a long-term perspective. The first great challenge is to create 12 million new jobs each year, to make the demographic dividend an economic dividend.
(This is an edited version of the article, which was published on the author’s blog.)