India’s Economic Crisis - Reality Has a Way of Catching Up

The tale of King Canute holds a salutary lesson to our Prime Minister. Canute set his throne by the seashore and commanded the incoming tide to halt and not wet his feet and robes. Yet continuing to rise as usual the tide dashed over his feet and legs without respect to his royal person.

Then the king leapt backwards, saying: 'Let all men know how empty and worthless is the power of kings, for there is none worthy of the name, but He whom heaven, earth, and sea obey by eternal laws.'" He then hung his gold crown on a crucifix, and never wore it again "to the honour of God the almighty King".

Like the seas, economies too cannot be ordered about. Any stopping of the rising waters requires long term and carefully constructed plans for dikes, sea walls and water concourses. This requires a time frame our leaders do not have the luxury of enjoying. So they create illusions that they can sell to the voting citizen consumer. Our Modiji is the master of illusion.

One of the first economic policy decisions of the Modi government was made in January 2015, to change the base year and method of calculating the GDP. Not that this has not been done before, the last time being 2010. To do it so soon after suggests with malice aforethought. For the change of the base year from 2004-5 to 2011-12 and switching to market price calculation of GDP boosted the GDP growth. Thus, during the last UPA year it changed from the 4.7% to 6.9%, suggesting that the Manmohan Singh government was doing quite well as far as growth was concerned.

This post facto boost of 2.2% given to the UPA then began to boost the GDP growth in the NDA2 era by 2.2% also. But even this didn’t help in sustaining the illusion of rapid growth that the Modi regime was trying to create. The problem was that even this was not working and nominal GDP – the GDP before adjusting for inflation – was falling.

It came down to 5.2%, but the Modi government got a windfall in the form of a deflation of about 2.2%. So the real GDP became 7.4% with the 2.2% boost it gave itself earlier that year. This enabled it to stake the claim of being the “fastest growing major economy in the world”. It was just statistical legerdemain.

In the real world, nominal growth matters much more than the inflation-adjusted real growth. To a firm’s revenue, whether from realizations from current sales or projections for future, cash flows and investments; real growth hardly matters. Nominal growth matters for the government too because tax revenues also are affected by deflation. The sharp decline in direct tax collections gave this away, but Modi and Jaitely are not ones to be bothered with such niceties and accuracies. To them it is all about creating a spin and sustaining it. This is a habit that persists. Fudging data and then misinterpreting them is now a part of their nature.

To compound matters, falling revenues also began to impact job creation and the mood of gloom and doom began to infect the public mind again. So in November 2016 Narendra Modi reached into his bag of tricks and pulled out another bunny. He went in for a ban of Rs.500 and Rs.1000 notes.

This was not a demonetization as is commonly understood by economists. It was a straight forward, albeit a somewhat draconian, note exchange scheme, but Modi is nothing without the drama. He termed it a Demonetization. Demonetization is described as “the act of stripping a currency unit of its status as legal tender. It occurs whenever there is a change of national currency: “The current form or forms of money is pulled from circulation and retired, often to be replaced with new notes or coins”.

The condition that usually forces demonetization is hyperinflation. And here we were experiencing deflation. But Narendra Modi does not burden himself with concern for terminological accuracy.

Narendra Modi stated three major objectives of this sudden and draconian announcement. The first was to force the “black money” back into the formal system. The second was to filter our counterfeit notes, and the last was to cut off terrorist funding. In November 2016, the total currency in circulation was Rs.17.97 lakh crores, 86% of which was in Rs.500 and Rs.1000 notes.

It was hailed by the government’s drumbeaters as a stroke of Modi’s genius that will result in a bonanza of Rs.3-4 lakh crores to the RBI. The government’s propaganda machine even showed clips of old notes being dumped in rivers and wells. The picture being painted was of the corrupt and tax evaders being scared out of their wits and just dumping the cash. But the people of India are made of sterner stuff and today 99.83% of the extinguished cash has come back to the RBI and it is still counting.

But well before the notes were counted, Modi went to work demonizing critics of demonetization as supporters of tax evaders, crony capitalists, criminals, corrupt bureaucrats and sotto voce politicians. He began to shout from the BJP’s election platforms in UP and elsewhere, where elections were soon to take place, that he was fighting the rich on behalf of the poor. It seemed to work, for in UP the BJP got a lopsided, even though somewhat diminished, electoral verdict. But did the net catch many counterfeits? The RBI’s answer is NO! Has terrorist funding ceased. The answer has to be no, as little seems to have changed.

By taking out that much money from the market, Narendra Modi inflicted a huge pain on an economy where 98% of all transactions accounting for 68% of the value are in cash.

At any given time about 150 million workers in the informal sector are daily wage earners and are still paid in cash. With the abrupt sucking out of 86% of the cash, it was this cohort who bore the brunt of the assault. The vacuuming of the cash led to huge job losses and tens of millions just went back to their villages. The economic costs have been estimated to be at least Rs.225,000 crores or 1.5% of GDP that year. It cost another Rs.40,000 crores to print new notes, some even in China we now hear, recalibrate ATMs and counting machines, and transport the cash, while people stood patiently in lines to get some of their own money back from banks. Over a hundred died in the waiting.

Now Modi’s drumbeaters are back playing their usual game. Distorting the truth. The Finance Minister is making a fool of herself claiming the auto slowdown is because millennials are increasingly using Uber and Ola. When the facts are that Uber and Ola growths are now almost flat. Then why are trucks, tractors and two wheeler sales plummeting? And above all why are the poor man's snack - Glucose biscuit - sales imploding?

Now the Modi propagandists also started claiming that the big consequence of demonetization was that the worms were coming out of the woodwork as IT returns were increasing. Sure income tax collections have spiked a bit. But that is mostly because of the back pays and new pays due to the generosity of the Seventh Pay Commission that gave 2.35 crores of government employees a 24% across the board hike. All government employees are now in the tax paying levels. The number of IT returns had been growing at a good pace since 2010. Following demonetization in November 2016, the returns filed for 2017-18 increased by 99.49 lakhs to 6.84 crores tax payers. This was 16.3% more than the addition of 85.52 lakhs returns filed in 2016-17. This is quite logical considering that the economy has been growing by about 7% for many years. It is also known that this 1% also accounts for 58% of India’s wealth. So why should it come as a surprise that the number of taxpayers too has been increasing?

The other big bang reform undertaken by Narendra Modi and announced in a dramatic midnight speech in Parliament was the Goods and Services Tax (GST), a tax regime which he was singularly opposed to as the CM of Gujarat and which he thwarted. There can be not much argument in favor of the old regime, which leaked like a sieve and gave plenty of scope for corruption. But in the hurry to get the Demonetization albatross off his back, Modi hurried through with this. The lack of preparation shows. Instead of a two-tiered system, we have a cumbersome five-tiered system. Since its launch it has been amended about 200 times. Instead of simplicity the new GST regime spread chaos.

One thing is commonly accepted, that is small businesses across the country, which together employ 110 million persons and contribute a third of the national economy are hurting. According to estimates by the well-regarded Centre for Monitoring Indian Economy, Mumbai, nearly five million workers lost their jobs over the past year. India's unemployment rate rose to 6.4% in August from 4.1% in July last year despite an additional 17 million people joining the workforce.

But the Prime Minister blithely keeps repeating that his MUDRA program is created employment for as many as seven million people in 2018. Modi says: “This data of seven million jobs is not like building castles in the air. It has been calculated by an independent agency on the basis of the Employees Provident Fund Organization figures." But here is the catch. EPFO only captures data of businesses with a payroll of over twenty, which means if you payroll of 19 goes up by just one, the data captured will tell you of twenty new jobs.

Then consider this. The government gave no budget for directly financing PMMY loans to businesses. It also gave no budget to Mudra for refinancing loans to other financial institutions. Mudra has a corpus of Rs 10,000 crores allocated by RBI from priority sector lending shortfall. Till March 31, 2017, Mudra drew Rs 8,125 crores from that corpus, sanctioned Rs.7492 crores (2015-17) and had an outstanding refinance portfolio of Rs 6,113.87 crore. However, total loans counted as Mudra stands at Rs 3.17 lakh crores. This erroneously gives an impression that Rs 3.17 lakh crores in new financing has been made available by the government. But that does not deter Amit Shah from asserting “more than 7.45 crores small entrepreneurs received loans worth more than Rs 3.17 lakh crores creating more than 7 crores self-employment opportunities”. But people without jobs know they do not have jobs and illusions will not convince them that things are getting better.

India’s crisis has been in the making for a very long time now. Our GDP has acquired the profile of a post industrial economy, which is excessively skewed towards the service sector, in turn giving our economy a post-industrial look despite not having industrialized in any significant way. 52% of China’s GDP comes from industry, while it is exactly half that for India. Agriculture employs 58% of our workforce and now contributes about 13% of our GDP.

Our crises are more systemic in nature and need a long-term perspective. Our first great challenge is to create 12 million new jobs each year, to make the demographic dividend an economic dividend. We are nowhere near that. To be able to create millions of more jobs, we need to make huge long-term capital investments. This can only come from the State as private capital is locked into an April 1 to March 31 perspectives.

The problem for Modi is how the government should go about improving its investment to GDP ratio, which in turn depends on the savings to GDP ratio? The record here is truly depressing. India reached a high of close to 41% in 2007. Since then it has been falling year after year and is now at 30.2%. The investment to gross domestic product (GDP) ratio (a measure of what part of the overall economy does investment form) peaked in 2007 at 35.6 per cent.

It has been falling ever since and in 2017, it had stood at 26.4 per cent. No other country in the world has gone through such a huge investment bust, during the same period. A fall in the investment to GDP ratio also suggests that enough jobs and employment opportunities are not being created. A recent estimate made by the Centre for Monitoring Indian Economy suggests that in 2017, two million jobs were created for 11.5 million Indians who joined the labour force during the year.

This is the reality that Modi needs to come back to.