What to trust on demonetisation: Official data or grim reports in media?

There is confusion as to how the economy is doing under the impact of demonetisation. The Index of Industrial Production rose by 5.7% in November as compared to the decline of 1.8% in October. This was unexpected and has given relief to the government which has been reeling under daily reports of industries and businesses floundering since November 8, when demonetisation was announced by Prime Minister Narendra Modi.

However, a report by the State Bank of India, based on a survey in Maharashtra in early January, suggested a sharp decline in business in Mumbai and Pune. Earlier, the All India Manufacturers’ Organisation projected a drop in employment of 60% and loss in revenue of 55% before March 2017. Another chamber of commerce and industry had shown that in different categories, between 80% and 50% of the enterprises surveyed reported a sharp drop in their business. The biggest fall in services and manufacturing in three years was noticed in Nikkei India Manufacturing Purchasing Managers’ Index or PMI data for December. Credit growth has been the lowest in 60 years.

Reports of distress among farmers have been appearing in the media. Farmers have not been able to get a remunerative price for their perishables like vegetables and have even given them away free or fed them to cattle or thrown them on the roads in protest. The government reports, however, show a 7% rise in acreage under rabi crops (sown in winter, in this period after demonetisation was announced) and a rise in off-take of fertilisers. The implication is that agriculture would not suffer a decline in spite of the hardships in rural areas due to the demonetisation-induced shortage of cash for carrying on farm operations.

The government has presented data to show that tax collection is rising and not falling. Direct tax collection rose 12% and indirect tax collection rose 25% in the April-December period in comparison to the same period last year. However, in the first three months, tax collection rose even faster, direct taxes by 25% and indirect taxes by 31%. The Value Added Tax collections by states showed an increase of 18% in November and for 17 states in December they rose by 9%. Does this imply that demonetisation did not affect production and sales, belying expectation of adverse impact of demonetisation?

But what about the anecdotal evidence appearing daily in the media showing a decline in industry after industry – automobiles, jewellery, plantations, construction, real estate, fast-moving consumer goods, health-care and so on. The decline seems to be not only in the unorganised sector but also the organised sector. The unorganised sector has reported massive retrenchment of workers and reports suggest that the unemployed workers are going back to their villages since they are unable to survive in urban areas. This has increased distress in rural areas since these people used to send money home to support their family. Now, they are adding to the burden on the family. There are reports of a sharp rise in employment sought under Mahatma Gandhi National Rural Employment Guarantee Scheme.

Who is right?

So, where is the catch? Is the official data or the anecdotal evidence daily being reported in the media correct?

Demonetisation immediately hit the unorganised sector and later the organised sector. So, in November, the unorganised sector production was hit and it led to unemployment there. This affected demand in the organised sector and led to an increase in inventories as sales fell. Indeed companies like GAIL were reported to be looking for additional warehousing to stock the unsold inventory of some of its products. So, production may not have immediately declined in the organised sector. This would have happened in the latter part of November.

The Index of Industrial Production reflects the organised sector performance. It is also often revised as more accurate data comes in with a time lag. Revisions can be large, especially when there is a sharp change in the economy, something that demonetisation triggered. So, we will have to wait for the correct data for November to come. Further, this data may not be representative of what is happening to the industrial sector because it does not directly capture unorganised sector data and that can cause a substantial revision later on.

The unorganised sector data are not directly captured in the Index because in many sectors it is assumed to be a proportion of the organised sector production. So, if the organised sector production does not show a fall, the data would not show a decline in the unorganised sector, even if actually there is a decline. So, demonetisation has led to a rupture between the two sectors and the Index does not capture that. Reports from hosiery and machine business in Ludhiana suggest that even in January business was down 50%. This is a much sharper fall than in the organised sectors.

The unorganised sector production is about 40% of the total. Assume that the non-agriculture component of this sector declined only by 50% over two months and then recovered to its October level, that is, had zero growth for the balance of the financial year. Further, if the organised sector is assumed to be stagnant rather than showing a decline, the rate of growth of the economy would drop sharply from 7% before November to about 2% for the year as a whole.

However, reports suggest that even the organised sector has taken a hit since not only demand from the unorganised sector has declined but even better-off sections of consumers have postponed discretionary demand. Thus, after inventory buildup in November, it would have cut production starting December. This is what the fall in demand for automobiles and other goods suggests. If this sector is assumed to only decline by 10% over the four months from December, the rate of growth of the economy would become zero for the year. If the unorganised sector does not stay flat at the pre-November figure after December but is less depressed (say, 20%), then the rate of growth would turn negative. How negative is hard to estimate at present with limited data available.

Correct comparisons

Agriculture sowing should not be compared with last year’s sowing but that in 2013—14, when the monsoon was normal. Compared to that, there is no rise. Further, there are reports that there was delay in sowing and applying inputs which would imply a decline in productivity compared to the past.

Tax collection could be higher for many reasons, and also perhaps because people used the old notes to pay taxes and arrears, like in the case of property tax. In the next quarter, there could be deceleration; one needs to wait. In the case of VAT, traders showed higher sales to recycle their cash holdings. This would also lead to higher direct tax collections. In brief, while sales may have fallen for different reasons, tax paid may have increased in the quarter for unrelated reasons, but this may not continue in the next quarter.

Stock markets initially declined but of late have gone up. The foreign investors have pulled out about Rs 70,000 crore not only due to the uncertainty introduced by demonetisation but also because of the rise in interest rates in the US. So, why has the market risen? It is not because the uncertainty has ended but because the financial institutions have intervened just as they do at the time of the budget to boost sentiment. But how long can they sustain the market in the face of lack of investment by individuals and foreign institutional investors pulling out?

Thus, positive data presented by the government needs to be reinterpreted to take demonetisation into account. And it could take a year for official data to reflect reality.

Demonetisation was a big shock to the economy and the government itself admitted that there would be pain. Ground reports seem to suggest that the pain persists. Should limited and preliminary data be allowed to trump reality on the ground?

Professor Arun Kumar is the author of The Black Economy in India, published by Penguin (India).