India’s economic slowdown may be worse than it appears

All quiet on the economic front.
All quiet on the economic front.
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After months of denial, India’s Narendra Modi government is finally conceding that the economy is in trouble.

The country’s gross domestic product (GDP) in the April-June quarter of this financial year grew at a meagre 5%—the lowest in six years. This is a steep fall from the roughly 8% growth clocked in the same period about two years ago.

What is alarming, though, is that even this 5% growth may be an overestimation given the many infirmities in India’s revised GDP estimation methodology introduced four years ago.

The sputtering engine

There is now no denying that the economy is losing steam, based on a host of economic indicators, besides GDP growth.

Most glaringly, automobile sales in August declined by nearly 25% year-on-year. The sector has seen large-scale retrenchments of workers, and major auto manufacturers have declared “production holidays.” Besides, growth in exports and imports have slowed down over the past five years and the average annual industrial growth rate in the same period, as measured by the Index of Industrial Production (IIP), is a dismal 3.5%.

Initially, the Modi government brushed aside these indicators, claiming that “New India” is a private consumption-led story, with large-scale employment being created in the gig economy, which is not adequately captured in official figures. Yet, recent events like the layoffs at restaurant aggregator Zomato, flies in the face of this official stance, and the government can no longer remain in denial.

However, all that is only a part of the story.

Dubious methodology

A country’s GDP is the money value of all goods and services produced in a given year, net of intermediate inputs. The growth in GDP is usually measured in “real” terms—or taking inflation into account.

For this, GDP at current prices is converted into constant prices, based on prices in a particular “base-year.” Roughly every decade or so, the base-year is moved forward to reflect changing economic structure, relative prices, and better data sources, among other things. Usually, such periodic revisions lead to a marginal expansion of “absolute GDP,” due to better capturing of economic activity, but “GDP growth rates” do not change.

In 2015, as a routine matter, India’s central statistics office introduced a revised GDP series with base-year 2011-12, replacing the earlier series which had 2004-05 as the base year. This time, though, it was different.

The absolute GDP in the base-year (2011-12) contracted 2.3%, while annual growth rates in the following years increased substantially. For 2013-14, GDP by the new series grew at 6.8% compared with 4.2% in the old series. The growth in manufacturing moved from -0.7% to +5.3%.

Such wild swings drew widespread suspicion, given that it was out of line with other economic correlates such as bank credit growth, and industrial capacity utilisation.

Two studies that have independently studied the official GDP numbers support the contention of a possible overestimation.

Based on a cross-country econometric exercise, Arvind Subramanian, India’s former chief economic advisor, concluded that the true average annual GDP growth rate between 2011-12 and 2016-17 maybe 4.5%, against the official estimate of 7%.

Sebastian Morris of IIM Ahmedabad (along with Tejshwi Kumari), in a time-series econometric exercise using official quarterly GDP data, has suggested that the average annual growth rate between 2012-13 and 2016-17 maybe 5-5.5%, compared with the official estimate of over 7%.

With each passing day, new anomalies have come to light.

For instance, the November 2016 demonetisation of two key banknotes was an economic disaster, according to evidence adduced by many scholars. It destroyed output and jobs, particularly in the informal sector, which accounts for between 45% and 50% of India’s GDP and up to 85% of employment.

Yet, puzzlingly, GDP for 2016-17 grew at 8.2%—the highest in the decade!

So how much is actual growth?

India’s GDP may now be growing at a much slower rate than the official 5%—probably somewhere between 3% and 4.5%.

If 4% is taken as the more realistic number, then most of the Narendra Modi government’s budgetary calculations would go haywire, as absolute GDP size is the “universal” denominator in macroeconomics.

For instance, to attain Modi’s target of a $5 trillion economy by 2024, the required annual growth rate would shoot up to over 10% from the official requirement of 8%. Even attaining the official 7% growth, recorded during the last five years, would be an uphill task as the recently-announced fiscal stimulus and banking sector rejig would appear too modest.

Only an ambitious public investment programme can pull the economy out of the rut.

In the early 2000s, when the economy was decelerating, the AB Vajpayee-led government triggered a cycle of infrastructure-led growth by launching the Golden Quadrilateral project to connect India’s metro cities by high-quality roads and the PM Gram Sadak Yojana to connect all villages by motorable roads.

Similarly, to address the much-discussed rural distress prevailing now, India’s mammoth jobs programme, the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), can be re-invigorated to revive rural capital formation and employment generation.

The state, therefore, must steer investment growth, until the private sector’s animal spirits are back.

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