Demonetisation dealt a big blow to the economy, but it was slowing anyway, and GST would always have destabilised things
So did prime minister Modi kill the economy by following up demonetisation with GST as many seem to be suggesting? Even if the government does not agree with former prime minister Manmohan Singh’s prediction of a DeMo-induced disaster, the fact that it is talking of the need for a stimulus package means it agrees the economy is sluggish and that jobs are not getting created.
There are, however, many caveats.The economy was slowing when Modi took over and with inflation at 9.4% and the fiscal deficit at 4.5% in FY14, India’s macros were poor (see graphic). Investment, which was growing at 16% in FY08, fell to 1.6% in FY14, private consumption slowed from 9.4% to 7.3% and government expenditure from 9.6% to 0.6%. Also, India was knee-deep in the twin balance sheet problem—both bank and corporate balance sheets were deeply in red—and getting out of this takes at least 5-6 years as the global experience shows.
None of this is to say Modi didn’t make major mistakes, he did. This newspaper has catalogued his wasted three years in fixing telecom, gas-pricing, freeing agriculture—this aggravated the rural crisis, and prolonged the slowdown in a big way —and poor progress in reforming labour laws or genuinely easing business or resolving the Pranab-era retrospective taxes… Indeed, Modi went the other way by imposing more controls in drugs pricing and even cotton-seeds and in creating bigger PSUs instead of privatising them… Even simple solutions such as the apparel package put together by chief economic advisor Arvind Subramanian took forever to put in place.
Yet, there has been good progress in fixing subsidies other than food, and even in that case, there is some progress. The pro-poor measures like JanDhan accounts, direct benefit transfers and low-cost life/accident/crop insurance are by all accounts a success. And at a time when there were few growth drivers, it was prudent budgeting that saw the government raise petroleum taxes and use the money to dramatically hike government capex in roads/rail—though Suresh Prabhu had to resign due to railway accidents, he began major reforms. In FY14-17, thanks to inflation collapsing, nominal GDP has slowed from 13% to 11% but tax-GDP still rose from 10.1 to 11.2, very unusual in low-growth periods.
While most macros like inflation or the twin deficits improved under Modi, it goes beyond good luck with lower global inflation—by that logic, the go-go years of the UPA were surely influenced by high global growth. Exports growth that averaged 26.4% in FY05-08 played a big role in the average GDP growth of 9.1% — in FY14-17, exports contracted 3.8% on average. The role of RBI in keeping interest rates high—and thereby the rupee getting stronger—is also a big factor in sluggish GDP growth as it restricted local production and encouraged greater imports — Modi is guilty of accepting inflation-targeting (IT) that made RBI behave this way, but IT was pushed by the UPA.
There can be little doubt that demonetisation added to the problem by badly hitting supply chains, especially in the informal sector, and it could be years before they revive, if at all—this is Manmohan Singh’s point. Demonetisation hit the real estate sector the most since that was a large user of black money, and this has large implications for jobs creation as well—along with the new RERA rules, though, reforming real estate will be a big plus if it makes housing affordable in the medium-term.
But, at a fundamental level, demonetisation and GST are not too different in their impact on the cash-rich informal sector—in both cases, informal sector units have no option but to get into formal chains and start paying taxes and, as happens with greater formalisation, pay higher wages, etc. Bringing in GST so soon after demonetisation surely accelerated the pain but which politician, including Manmohan Singh, has not been pushing for GST for years due to its long-term benefits? And we can quibble about the timing, but GST had to be brought in 2-3 years before the elections so that the pain associated with it was absorbed over time. That is, if DeMo hadn’t hit the informal sector, GST would have, albeit at a more gradual and more manageable pace.
Once DeMo or GST were brought in, MSMEs lost their tax-arbitrage-driven USP. The only way to fix this was to raise their efficiency —that requires big reforms in labour rules, tax policies … what are called ease-of-doing-business (EoDB) rules. Modi’s failure is that he felt EoDB had been fixed and was unwilling to accept any criticism of this. Nothing cures hubris better than a slowing economy though Modi’s 2019 plank will be more money in the hands of the poor and much lower inflation.