Rebooting Economy XXV: How a series of economic misadventures derailed India's growth story

Rebooting Economy XXV: How a series of economic misadventures derailed India's growth story

This is Part I of two-part article revisiting critical economic decisions that eventually led to minus 23.9% growth in Q1 of FY21. Blaming exogenous factors (pandemic) or intense lockdown is merely an excuse to divert attention from government's ineptitude and thwart meaningful debate

Like demonetisation, GST was brought in without preparation Like demonetisation, GST was brought in without preparation

Why did India take a far bigger COVID-hit to its GDP than other major economies in the world? How and why did the fastest growing economy legitimately aspiring for higher growth and prosperity flounder, ending up in a big economic mess and robbing millions of aspirational Indians of their dream?  

That growth had slowed down even before the pandemic hit and an untimely, unplanned and sudden lockdown delivered the knockout punch is known. That there have been many economic misadventures in the past six years that put a heavy cost is often lost sight of. Those misadventures deserve to be retold and reassessed to save India from a further encore.  

The best way to begin this is to take a close look at the GDP growth ever since the incumbent government took charge. The graph below highlights some of the key misadventures that shocked the Indian economy.

New GDP 2011-12 series sets the tone for data fudging

Contrary to popular belief, the first major shock to the economy was not the demonetisation of November 2016, it was the introduction of a half-baked, highly defective new GDP series of the base year 2011-12 in January 2015 that shattered credibility of the Indian economic statistical system.

The new GDP series dramatically increased the growth rate which for FY14 jumped from 4.7% (under the old 2004-05 GDP series) to 6.9% and that of FY13 from 4.5% to 5.1%, taking it past China's growth and creating a false narrative of India being "the fastest growing economy".

Since multi-lateral agencies like the World Bank, International Monetary Fund and UN bodies use official data, India got a fresh coat of paint overnight. It was no longer a "fragile economy". (For more read "Data fudging: Dressing up GDP and budget numbers does no good to economy ")

Four years later in June 2019, the then Chief Economic Advisor (CEA) Arvind Subramanian, who had resigned by then, wrote a paper for Harvard University saying India's growth had been exaggerated by around 2.5 percentage points between 2011-12 and 2016-17. When he was challenged, he delivered another shock: "Since the underlying data are not available publicly, nobody outside the CSO can "estimate GDP".

The second shock was because India had never used a secret database to bring in a new GDP series until January 2015. This secret database was untested and turned out to be highly defective and completely unreliable. Subsequent years would show a similar brazen data fudging would occur again and again to render the GDP data meaningless.

The secret database was MCA-21, a self-populated site of the Ministry of Corporate Affairs (MCA) containing the output of corporate entities in manufacturing and services, which has never been made public.

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Four years later, in April 2019, the MCA-21 database was exposed by none other than the National Sample Survey Office (NSSO), a government body which has been dismantled now.  

Its report, "Technical Report on Services Sector Enterprises in India 2016-17", pointed out that when its data was verified for accuracy, 45% of units in the services sector alone (it did not check the manufacturing units) turned out to be defective.

It said: "About 45% of MCA units were found to be out-of-survey/casualty...". What it meant was that 45% of the units in the MCA-21 database don't exist, don't operate or are engaged in unrelated activities.

It also pointed out that such errors in other databases used earlier, the Economic Census (EC) and Business Registers (BR) of states, had an error margin of 18%.  

Not just an artificial boost to the GDP, the highly defective MCA-21 data also drastically altered the structural composition of the economy. It cut the share of services and boosted manufacturing by a huge margin. A comparative analysis of the fiscals for which the old 2004-05 and new 2011-12 GDP series provide data is presented below to show the dramatic overnight change.

For FY14, the last year for which comparable data exist under the two GDP series, the share of services fell to 59.9% from 67.4% and that of manufacturing went up from 14.9% to 17.2%.  

By then, a new flagship programme 'Make in India' had been launched (September 2014) to turn India into a manufacturing hub and raise its share in GDP to 25%. With the flawed new GDP series (2011-12 base), manufacturing's share had inched 2.3% closer to 25% without making anything in India.  

The 'Make in India' and similar hyped programmes like 'Skill India' and 'Stand up India' have been given a quiet burial.

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Demonetisation that shocked India's growth

This was a "shock and awe" operation. Suddenly, at 8 pm on November 8, 2016, Prime Minister Narendra Modi banned high-value currency in circulation from midnight with less than 4 hours' time.  

The demonetisation killed 86% of cash in circulation in a very much cash-based economy. All of India queued up outside banks for months to withdraw their own money by exchanging old with new notes because the government ordered rationing of cash. The central bank RBI, operational since 1935, couldn't print enough notes in time or notes that would fit millions of ATMs across the country which had to be recalibrated.

It killed all work at once; millions of casual and self-employed workers lost livelihoods in four hours. Many died in queues or starved to death. It killed small businesses and derailed big businesses. Nobody knows the extent of economic devastation it caused because the government didn't want.

More than two years later, on November 27, 2018, a highly respected national daily revealed: "Reversing its earlier report that conceded for the first time that demonetisation had affected millions of farmers, the Union Agriculture Ministry has submitted a fresh report claiming that there was no "adverse impact". Agriculture Secretary Sanjay Agarwal informed the Parliamentary Panel on Finance that show-cause notice had been served on two directors and a joint secretary for the earlier report."

The quarterly GDP graph presented at the beginning gives a flawed picture; the damage was far more severe and derailed the Indian economy.

Whose idea was it? Who drafted and vetted it? Who all were consulted? How much time was given to prepare? What were the precise goals and economic logic to support? Nothing is known for certain because the government refused to answer any questions, not even under the Right to Information (RTI) Act of 2005.

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It was presented as a major economic reform that would (i) end corruption in India (ii) end black money in India, extinguish Rs 4.5 lakh crore in the process (iii) end terror funding and (iv) turn India into cash-less economy overnight, among others that kept piling up as days went by.  

Who provided the calculation that demonetisation would extinguish Rs 3-4 lakh crore, resulting in a windfall gain to the RBI and government?

That is difficult to answer but some indications do exist.

The following is an extract from the leading public sector bank SBI's March 2016 newsletter EcoWatch. It raised an interesting point, provided detailed arguments with mathematical formula to justify it and 8 months before the demonetisation was thrust on unsuspecting Indians, it used the word "demonetisation".

Later, on November 14, 2016 (a week after demonetisation) SBI's chief economic adviser Soumya Kanti Ghosh revealed more. In his article in a business daily, "Demonetisation and note burning", he wrote: "Based on such estimates (three plausible scenarios), roughly around Rs 4.5 lakh crore of money could disappear from the system."

On November 23, 2016, he wrote again in the same daily, "Grappling with demonetisation windfall".

Confident that windfall gain had already been made, Ghosh discussed its "end-use", tentative about the amount, but more certain that "money (Rs 2.4-4.8 lakh crore) will not be converted and remain outside the banking system".  

That never happened, the money came back and SBI never spoke about it again.

In the meanwhile, something weird happened.

The Income Tax department set out to search the missing windfall gain. Forbes magazine ran a headline on January 10, 2017, that captures the essence well: "India's Demonetisation - 3-4 Lakh Crore Untaxed Cash Deposited, IT Department To Investigate".

This loss of windfall gain would eventually set the Centre after the RBI and demand this amount from its reserve money. A committee under former RBI Governor Bimal Jalan would facilitate but set the bar lower following which the RBI decided to transfer Rs 1.76 lakh crore in August 2019.

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Finance Minister Nirmala Sitharaman was asked by reporters what would she do with it. She said she had no idea ("abhi bol nahi sakti" were her exact Hindi words).

That was August 27, 2019.  

Less than a month later, on September 20, 2020, the Centre announced a massive corporate tax cut of Rs 1.45 lakh crore.

Another development took place on the same day (September 20, 2019).  

Sitharaman told states at the GST Council meeting in Goa that the Centre was facing financial difficulties in paying the GST compensation and in November 2019, she wrote to them saying that their demand for the agreed compensation (legitimate demand) is "unlikely to be met". This would snowball into a major confrontation in August 2020.

How much damage the demonetisation caused?  

The then CEA Subramanian had resigned by now, published a book (November 2019), "Of Counsel: The Challenges of the Modi-Jaitley economy", and touring India describing demonetisation as "a massive, draconian, monetary shock" that plunged GDP for the next 7 quarters. He said, in six quarters before the demonetisation growth averaged 8% and in the seven quarters after, it averaged about 6.8%.

The quarterly GDP graph at the beginning does not show it. Quarterly GDP started rising three quarters later. Was Subramanian lying?  

No. The GDP data has undergone multiple revisions since then to resemble reality.  

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The demonetisation happened during his tenure but he never disputed or protested. He did not disclose why he allowed it or whether he was consulted at all. Two years earlier, in 2017, former RBI Governor Raghuram Rajan had gone back to teaching at the Chicago University and wrote a book "I do what I do", revealing in it that he had opposed demonetisation.  

Urjit Patel replaced Rajan as RBI Governor in September 2016. Two months later, on November 8, 2016, demonetisation was declared. For the first time in its history, the RBI failed to print adequate currency notes for months, leading to cash rationing at banks. The RBI also failed to print notes that fitted the millions of ATM cash dispensers all around India, leading to recalibrations of these dispensers.

Patel resigned in December 2018 and has authored a book "Overdraft: Saving the Indian Saver' (released in July 2020). He talks of his fight to save the Insolvency and Bankruptcy Code (IBC) in the book but not the most critical decision he took that destroyed the livelihoods of millions and derailed the Indian economy in an instant.  

Why did he allow demonetisation? How did RBI fail in its routine business of printing currency notes and why did it design notes that didn't fit the ATM dispensers? He is not revealing.

Here is another interesting side. Under Patel, the RBI took 21 months to count the already counted money to declare that 99.3% of currency notes had come back in its report in August 2018.

For the uninitiated, the RBI gets such details every day from banks; banks count money before taking it from people and record it electronically. Besides, the Centre had also rushed tax officials by January 10, 2017, to search for the missing windfall gain.

GST further damages organised and unorganised businesses

The GST was ushered in at a midnight session of Parliament on June 30-July 1, 2017, just like India's independence had been on the night of August 14-15, 1947 with Nehru's famous "tryst with destiny" speech.  

That is because it was billed as the "second freedom fight", advancing the celebration (midnight session of Parliament) to the starting point of that imaginary fight though. Like demonetisation, the GST was supposed to end corruption and black money. Plus, it would epitomise "cooperative federalism" and boost GDP. It was supposed to merge 17 Central and state indirect taxes.  

It achieved none of it. Instead, it is facing an existential crisis now.  

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By the last week of August 2020, states had started demanding its roll-back and threatened to derail "cooperative federalism" because the Centre is asking them to borrow money from the RBI in lieu of GST compensation it was to pay them.

Explaining the Centre's failure to honour a legally binding provision of compensating states - GST Cess is meant to raise that money for five years for states sacrificing their right to tax and source of revenue - Sitharaman described the economic crisis as an "Act of God".

Sitharaman was economical with truth. She didn't explain why the Centre gave a massive tax cut of Rs 1.45 lakh crore to corporate entities on September 20, 2019, the day she was telling states at the GST Council meeting in Goa that she had no money to pay them GST compensation.

Ironically, the corporate tax cut was sold as a move to boost investment and employment.

Nothing could be farther from truth.

The RBI nailed it in its 2019-20 annual report made public on August 25, 2020.

It said: "The corporate tax cut of September 2019 has been utilised in debt servicing, build-up of cash balances and other current assets rather than restarting the capex cycle. These underlying developments suggest that the appetite for investment is anaemic and in need of more reforms."

Meanwhile, the GST is deeply flawed in both design and implementation, imposing high cost on businesses and incentivising tax evasion. (For more read "Rebooting Economy XXIV: 7 critical GST flaws govt needs to address at the earliest ")

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It is not fully operational yet, tax refund claims are granted without verification, its IT backbone, GSTN is not fully operational and all filing requirements (GSTR-2 for inward supplies and GSTR-3 for summary of outward supplies not yet issued) and tax audit compliances (GSTR-9C) are not yet in place.  

Like demonetisation, GST was brought in without preparation. It ended up damaging both unorganised and organised sector enterprises. Businesses also shifted from unorganised to organised sector, damaging further those who had suffered huge losses due to demonetisation a few months earlier.  

Part II of the article will look at some other economic misadventures that derailed the Indian economy.

Published on: Sep 10, 2020, 5:39 PM IST
Posted by: Manali, Sep 10, 2020, 5:39 PM IST