Even as the adverse impact of demonetisation is now fading, a new potential shock to the economy is raising its head — the implementation of the Goods and Services Tax.
The evidence to support the argument that demonetisation will hurt the Indian economy is now out: at 6.1%, the slowdown in India's GDP (Gross Domestic Product) growth for the January to March 2017 quarter is the lowest in two years, down from 7.4% in the previous quarter and 7.6% in the same quarter of the previous year. With it has gone India's position of being the world's fastest-growing large economy. That title now returns to China, which grew by 6.9% in the same period. Worse, Gross Value Added (GVA) — the value added by capital and labour to production, or GDP minus taxes and subsidies — for the quarter grew by 5.6%, compared to 6.7% in the previous quarter and 8.7% in the same quarter of the previous year.
What was sold as a silver bullet for all economic and moral ills, from corruption and black money to terror funding and counterfeit notes, by the government has turned out to be a blank that has slowed the economy down, or so goes the perception. The series of anecdotes that several observers recorded and which Finance Minister Arun Jaitley lobbed off as irrelevant is now out in the slower growth number. "All these stories and reports are anecdotal," he had said following the 14.2% increase in indirect taxes mop up for the quarter ended December 2017. "The growth figure does not depend on anecdotal basis. Statistics and taxation figures are real. This is the money which has come in." Now that the anecdotal evidence has become empirical, he might want to revisit his all-is-well economic thesis.
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That may not happen. The government continues to underplay demonetisation as a cause for the slowdown. "Every policy decision has an implication.. so has demonetisation, but to disintegrate the impact of one decision is a complex task," Chief Statistician T.C.A Anant said, while releasing the numbers on 31 May. "The GDP (number) is quite expected with what we said in the Economic Survey, the demonetisation was a temporary shock, and the economy recovered with remonetisation," said Chief Economic Advisor Arvind Subramanian.
Demonetisation, the survey stated, will potentially shock the economy on three counts. One, aggregate demand shock, because it reduces money supply and affects private wealth (especially of those holding unaccounted money and owning real estate). Two, aggregate supply shock to the extent that cash is a necessary input for economic activity. And three, an uncertainty shock because economic agents face imponderables related to the impact and duration of the liquidity shock as well as further policy responses, causing consumers to defer discretionary consumption and firms to hold investment plans.
If government economists are beating about the bush, the views of non-government economists are congruent about the causality of demonetisation on the GDP growth slowdown. "The impact of demonetisation is clearly visible in fourth quarter GVA growth of manufacturing," India Ratings chief economist Devendra Kumar Pant said. "Q4 data is definitely disappointing and clearly reflects some amount of extreme impact from demonetisation," Mizuho Bank Indian strategist Tirthankar Patnaik told Reuters.
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Perhaps we're looking at data too closely and jumping upon the first causality to fit a narrative. More so, because, after the first two weeks, the Reserve Bank of India (RBI) had stopped disseminating information about the state of demonetisation, leading the people to suspect that there was something amiss, that the RBI in tune with the government wanted to hide the downside that demonetisation brought — the terribly long lines of consumers at ATMs powering the lack of empirical evidence by anecdotal hardships. Now that the numbers are out, those anecdotes have suddenly become legitimate.
We need to step back.
The cash shortages and payment disruptions due to demonetisation were expected to slow the quarter. That's not the surprise. The surprise is that the fall has been only marginal. Even at 6.1%, India's growth is enviable — it is nowhere close to the two percentage point fall that former Prime Minister Manmohan Singh had forecast, while calling the move "monumental mismanagement", "organised loot" and "legalised plunder" of the common people.
Now that the short-term shocks of demonetisation are behind us in the form of slower GDP growth, it's time to look at the long-term benefits, of which, according to World Bank's India Development Update, are three: "Formalisation of the economy; increased tax collection, and greater digital financial inclusion." That we have been able to get out of this shock with minimal damage of less than 1% shows India's economic resilience. It also displays our fears, apprehensions and even contempt for new economic policy experiments.
Even as the adverse impact of demonetisation is now fading, a new potential shock to the economy is raising its head — the implementation of the Goods and Services Tax (GST) across India from 1 July. Between lack of awareness of this completely digital modern system of taxation and a tax bureaucracy that has thrived on extracting rents from entrepreneurs for several decades now, the first quarter, maybe even two, of its implementation are going to deliver more shocks to GDP growth. According to government officials, forget growth, we might see a contraction as getting on to the new system takes energies away from doing business to managing input credits, understanding the nuances, and figuring out and feeding a ravenously hungry compliance system.
While a contraction of output may be an exaggeration, we must keep in mind the fact that any new system of taxation carries with it a learning curve whose currency is time. So, even though the GST system comes embedded with digital conveniences that will reduce costs and GST Suvidha Providers that will help with the transition, the learning lag could show up in a slowdown, definitely in the first quarter and possibly in the next. But once the cobwebs of compliance — the biggest threat facing Indian entrepreneurs today — get cleared up, the increase in the velocity of transactions, the efficiency of tax collection and the benefits to doing business will come together in a virtuous cycle and power growth.
Taken along with demonetisation that will continue to catalyse the shift of the informal economy to the formal in the medium term, the dip in GDP growth due to GST transition for a quarter or two may merely be a pause as the economy settles down to a new and more effective equilibrium. But if the transition to GST remains rooted in the past, and despite the political leadership pushing for growth the red tape and rent seeking by the tax bureaucracy continues unabated, expect a longer and colder winter of growth contraction.
The GST Council that meets on 3 June needs to keep this in mind.
The views expressed above belong to the author(s). ORF research and analyses now available on Telegram! Click here to access our curated content — blogs, longforms and interviews.
Gautam Chikermane is a Vice President at ORF. His areas of research are economics, politics and foreign policy. A Jefferson Fellow (Fall 2001) at the East-West ...
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