In black and white: Do the GDP numbers confirm that demonetisation has made a bad situation worse?

After a higher-than-expected growth of 7% in the third quarter of financial year 2016-’17, India’s Gross Domestic Product grew a mere 6.1% in the fourth quarter (January to March), according to government data released on Wednesday. This is most likely the impact of the government’s demonetisation move, implemented in November. However, the Central Statistics Office pegged the GDP growth for the entire financial year 2016-’17 at 7.1%, in line with its earlier estimates.

Stark deceleration in growth

The financial year 2017 marks the first time economic growth has decelerated in recent years. Since the 2013-’14 financial year, India’s GDP growth had climbed steadily: from 5.5% in 2012-’13 to 6.4% in 2013-’14, 7.5% in 2014-’15 and 8% in the previous financial year. This steady rise is now over: at 7.1%, India’s GDP growth for 2016-’17 has taken a hit of nearly one percentage point.

This comes despite the fact that the Central Statistics Office this year switched to a new series of Index of Industrial Production (which measures the growth of various industrial sectors) and Wholesale Price Indices (a measure of inflation) for compiling the growth estimates, using 2011-’12 as the base year instead of 2004-’05 earlier. The new series was expected to raise growth estimates.

The Central Statistics Office also releases data on real gross value added by the economy, which is calculated by deducting net indirect taxes (such as excise, customs, and service tax) from the GDP, and is said to better reflect the contribution of actual economic activity to growth (as opposed to taxes paid). The gross value added data shows the extent of the slowdown. Manufacturing growth fell to 7.9% in the 2016-’17 financial year, from 10.5% in 2015-’16, construction growth fell to 1.7% in 2016-’17 from 5% in 2015-’16.

On the positive side, the agricultural sector saw an increase in growth to 4.9% in 2016-’17 from 0.7% in 2015-’16

A story of four rough quarters

On a quarterly basis as well, the deceleration in growth was visible from the first quarter itself – from 7.9% in quarter one of 2016-’17, growth has steadily fallen through the year, hitting a low of 6.1% in the fourth quarter.

The gross value added story appears grimmer, with growth falling from 7.6% in the first quarter to 5.6% in quarter four.

A close examination of the gross value added data shows the extent of slowdown across sectors in 2016-’17:

• The construction sector, which was growing at 3%-4% from quarter one to quarter three, witnessed a contraction. Thus, in the fourth quarter of the 2017 financial year, construction sector output registered a decline of 3.7%.  
• Trade, hotels, transport and communication services sectors, which were growing at 8%-9% in the first three quarters, saw a deceleration of growth to 6.5% in the fourth quarter.
• Manufacturing sector growth halved from 10.7% in quarter one to 5.3% in quarter four. 
• Financial, real estate, and professional services sectors growth went from 9.4% in quarter one to 2.2% in quarter four.
• The only saving grace was the government sector (public administration, defence, and other services), where growth nearly doubled from 8.6% in quarter one to 17% in quarter four. This likely reflects the ramp-up in government expenditure during the year.

As the Mint reported, “Excluding agriculture and public expenditure, core GVA [Gross Value Added] grew 3.8% in the fourth quarter, revealing the deeper impact of demonetisation and suggesting that economic activity would have been much slower without a substantial push in public expenditure.”

Demonetisation picture now clearer

As mentioned earlier, economic growth had been slowing down from the first quarter of 2016-’17 itself. Data released by the Central Statistics Office shows the slowdown continuing in the second half, even deepening for large sectors such as construction. Thus, was demonetisation responsible for the added deceleration, especially in quarter four?

According to this report in the Times of India, Chief statistician TCA Anant said a separate analysis was needed to assess the impact of the note ban on growth, but admitted it could be one of the factors that may have impacted the economy in the third and the fourth quarter.

A strongly worded editorial in the Business Standard said that the new estimates gave clearer picture of the health of the Indian economy. It said:

“Starting April 2016, the Indian economy had started decelerating and this process was accentuated in the second half of the year, crucially after the government’s decision to demonetise 86% of the currency – a move that shook the already beleaguered economy. Both gross fixed capital formation and private consumption as a percentage of GDP slowed down to 28.5% and 57.3% respectively, in the fourth quarter when compared to the third quarter.    

Will things turnaround next year?

Booming equity markets seem disconnected from stories of slowdowns. And if equity indices such as the Sensex and the Nifty – both have been high in this calendar year – are leading indicators, then the Indian economy is poised for a turnaround in the 2017-’18 financial year.

However, the continuing problem of bad loans that has stymied India’s banking system, and the slowdown in the industrial sector shows that a sharp turnaround appears unlikely any time soon. Going back to the 8% growth levels seen in financial year 2016 seems to be an uphill task.

Anupam Gupta is a chartered accountant and has worked in equity research since 1999, first as an analyst and now as a consultant. His Twitter handle is @b50.