Indian economy in slowdown, needs structural reforms

The latest gross domestic product (GDP) data published by the Indian government (compiled by the Central Statistics Office (CSO)) indicate the Indian economy is slowing down to a 5.0 per cent growth rate, not seven or seven and a half per cent as claimed by the government. The GDP growth figure as claimed by the government was challenged by its own former economic adviser Arvind Subramaniam who had said that the growth rate was 4.5 per cent. He was clearly alluding to GDP data manipulation by the government. On that basis if the official figure is 5.0 per cent growth rate, then how much lower the actual growth figure may be is a matter of conjecture.

Why is this confusion about the published data on GDP? The reason is the methodology to estimate India’s GDP and its growth rate was changed in 2015. Ever since this change in the methodology has been instituted, there have been credible challenges to the methodology from economists both within and outside the country questioning the accuracy of the published GDP data. Arvind Subramanian, former Chief Economic Adviser to the Government of India (2014-2018), is in the forefront among those sceptics. According to his own calculation he opined that the GDP growth rates might be inflated by as much as 2.5 percentage points. Obviously, the Modi government dismissed such criticism as political rather than economic.

What was the changeover in the methodology that has created this controversy over the GDP growth rates? Data collection on the Indian macroeconomy started during the British colonial rule in 1914, and it was volume-based estimates. This system of volume-based estimates, which ultimately have taken the shape of product method of GDP estimation, was retained and continued in independent India until 2014. The government used volume-based estimates where changes in volume to volume of output were the basis of estimating the GDP growth rate. But that formula was changed in 2015 using 2010-11 as the base year. The new formula to estimate GDP now stands as, volume+ productivity+ qualitative improvements.

There are many limitations involved in estimating GDP that can be found in any standard macroeconomics text-book, and for very valid economic and statistical reasons those could not be remedied unless the very theoretical foundation of the concept of GDP is changed. Now it appears the Indian government statisticians and economists have tried to remedy some of those limitations, but one wonders how did they do it when others have failed. It, however, appears the statisticians at the CSO have picked up selectively those limitations that would enable them to inflate the GDP growth rate by double counting some of the factors that are taken into consideration in the current GDP estimates. No wonder many, including Arvind Subramanian, argue that this changeover in the methodology of estimating GDP has succeeded in boosting the GDP growth rate by some 2.5 percentage points.

Economic growth as reflected in the GDP growth rate is not a good indicator of the robustness of the economy, it rather tells us how small or large the economy was during the period it was estimated. Even if one accepts India’s inflated GDP growth rates at 7.5 per cent, what has the country achieved to change the size of its economy? The Indian economy still remains much smaller than those of the major economies in the world – one-fifth of China, one-twentieth of Japan and whopping one thirty-second of the US – on the basis of per capita income. While the Indian government’s published data on growth rates are very impressive at 7.5 per cent relative to 2.0 or less than 2.0 per cent growth rates in developed countries, the country will continue to remain a very small economy in comparison with those developed countries.

India has scale and scale encourages ambition. Prime Minister Modi has promised to turn India into a US$5.0 trillion economy by 2024 but such an assertion is equivalent to talking about doubling India’s agricultural income by 2022. Despite all the hypes about India’s growth and development, its capital city New Delhi goes under poisonous smog every winter due to massive air pollution caused by vehicle emissions and industrial pollution. Agricultural burning in the neighbouring provinces further adds to the smog problem. It is estimated that 10, 000 people die of this pollution-related problem each year. Also 5000 children die every day from hunger and malnutrition. According to the 2019 Global Hunger Index (GHI), India is ranked 102 out of 117 countries placing it behind its South Asian neighbours like Pakistan, Bangladesh, Nepal and Sri Lanka. Yet there is a growing problem of obesity, including child obesity and diabetes in the country.

The government is trying to allay public concerns saying that the economy is on track and the current slowdown is just a blip blaming that any criticism is politically motivated. Even those who recognise that there is a slowdown, they insist that the problem is cyclical not structural, and the government agrees with this line of reasoning. But the government-published data from Q1, 2016 to Q1 2019 indicate a clear downward trend in the GDP growth rate and so is investment from 2014. Also gross fixed capital formation and gross domestic savings as a percentage of GDP since 2011 have been on the decline. The level of exports remains stuck at 2011.

Raghuram Rajan, a former Chief Economic Adviser to the Government of India, suggests that the current slowdown is the culmination of two factors – slowdown in the pace of investment since the GFC (2007-2008 Global Financial Crisis) and the lack of economic reform which clearly indicate the problem is more structural than cyclical.

The economic slowdown is most evident in the manufacturing sector, especially the auto industry. While the government attributes the decline in car sales to millennials moving away from car ownership to Uber and Ola, the numbers really do not add up and the car manufacturers dismissed the government’s assertion. The decline in aggregate demand is mostly attributed to increasingly skewed income distribution towards the rich. The current slowdown has coincided with very low inflation, yet it has not helped to stimulate demand. Obviously, that indicates economic slowdown and lack of wage growth. Unemployment is more than 6.0 per cent and is rising – and now stands at a record level for the last 45 years time.

Indian economic growth is driven by household consumption accounting for 60 per cent of contribution to GDP. No wonder stagnant wage growth and rising unemployment are playing major roles in the current slowdown in economic growth by depressing household expenditure. To add to the economic woes, the consumer demand deficit is not offset by increased exports. In fact, exports are stuck at the 2011 level.

Many point out that over the last three decades or so there has been a shift in income distribution towards the upper income bracket, especially the very rich. Since Modi and his party BJP came to power, the process of rising income inequality has further been accelerating as his government started to cosying up to the corporate sector. It has been reported that during the general election that was held around the middle of this year, BJP received Rs 270,000 million funding from the corporate sector.

Such massive corporate largesse dished out to the BJP election fund now stands in the way to taxing the rich through income and wealth taxes. In fact, finance minister Nirmala Sitharaman scrapped the proposed tax surcharge (a tax on the very rich). She also cut the corporate tax rate from 35 per cent to 25 per cent. The income taxation system in India has proved to be ineffective in generating sufficient tax revenue to maintain fiscal discipline. As a result, the government is unable to stimulate public demand at a time of economic slowdown. There are now attempts to streamline a consumption-based tax (GST) which mostly hit the lower-income consumers as they have a very high propensity to consume relative to their income and exactly the opposite is true for the rich. The overall result of such a regressive tax is the slowdown of household expenditure.

The finance minister also took measures to shore up the beleaguered financial sector which is saddled with Rs10 trillion non-performing loans (NPLs). Her hope, this would bring down bank lending rates resulting from achieving economies of scale through mergers of public sector banks. The Reserve Bank of India, country’s central bank, has cut interest rates four times since the beginning of this year and one more may happen before the end of the year. But such interest rate cuts made no discernible impact on investment. In periods of sluggish consumer demand, no amount of interest rate cuts is going to make much difference as can be seen from the US, Japan and the European Union (EU). The impact of the demonetisation is still lingering on.

Also, at the same time income inequality is rising between urban and rural areas. The current economic crisis is further aggravating the long-standing rural distress in India. Despite spectacular rise in agricultural output, Indian farmers are languishing in poverty. Every year many farmers commit suicide to escape massive debt burden. According to the National Crime Record Bureau, 8007 farmers committed suicide in 2017 and this does not include suicide by agricultural labourers which is estimated to be at 5000. But many suggest that the actual figure is much higher.

The “Green Revolution” turned India into a food surplus country. But that revolution is now turning into a nightmare with falling water table, air and water pollution, and environmental degradation. The Green Revolution also failed to address the persistent problem of malnutrition and stunting among children. The Global Hunger Index (HDI), 2019 ranked India 102 out of 117 countries with a score of 30.3 which indicates India is suffering from serious hunger problem. In the Punjab, the heartland of the Indian Green Revolution, farmers regularly commit suicide. Agrarian distress in India has been building up over time and getting even worse. In recent times the rate of growth of agricultural output has almost halved. This is the direct consequence of falling agricultural commodity prices and that has put the huge rural population under financial stress.

Prime minister Modi has put tremendous effort and time into convincing the Indians that nothing is wrong with the Indian economy. Arguably, one may ignore the alternative estimates of the growth rate but macroeconomic aggregates like household consumption, private investment and other indicators show that the economy is in a downward slide. Since India’s independence, its economic progress has been very slow and uneven due to deeply embedded structural constraints. To ride out of the current economic crisis, Modi must recognise that India needs structural reform which alone can create an enabling environment for sustained economic growth.

But BJP’s election victory with increased majority has encouraged Modi so much that he is now more focused on carrying through his Hindutva agenda. Since his election victory this year he has pushed measures through parliament to change religious demographics in Kashmir to render the Muslim-majority in the state into a minority, and now as an added bonus he is savouring his legal victory to build a Hindu temple over a 500-year-old mosque.

Muhammad Mahmood is an independent

economic and political analyst.

The article appeared in the Financial Express