GDP estimates for third quarter of FY 2016-17 have surprised many people. Despite headwinds to growth from demonetisation, GDP growth has been pegged at 7% in quarter ending December 2016, while overall growth for FY 2016-17 has been estimated at 7.1%. This is in stark contrast to various estimates, including the International Monetary Fund’s which had expected economic growth to fall to 6% in the second half of the current fiscal year.
The numbers are likely to trigger a debate among economists and commentators whether they have captured the full impact of demonetisation.
Esther Duflo, a development economist at Massachusetts Institute of Technology (MIT), had hinted that GDP numbers would probably not capture the impact of demonetisation pain, as India’s official statistical machinery has limited capability to measure its huge informal economy .
Wednesday’s Mint editorial has also dwelled on the question whether demonetisation’s adverse effect on economic activity would be more pronounced in the last quarter of the ongoing fiscal year.
Having listed these caveats, two set of statistics can be cited to show that the government might have strategically mitigated the adverse impact of demonetisation through its timing and fiscal policy.
Speaking in Parliament on the demonetisation issue, Prime Minister Narendra Modi had said that the government waited for the festive season to get over before announcing demonetisation in November. This seems to be a strategic decision. Latest GDP numbers show that the year-on-year growth in private consumption expenditure (PFCE) is at an all-time high since September 2012. This would have seemed natural given a normal monsoon after two successive drought years and the festival season effect. Did tailwinds from these two factors more than take care of demonetisation-triggered headwinds? GDP statistics show that PFCE’s share in GDP normally shows a spike in the December quarter and was at its third highest level since June 2011 in December 2016.
While the faith in bullish spending behaviour might have been a tactical bet by the government, it stepped up its spending to offset the negative multiplier effect due to demonetisation. Government Final Consumption Expenditure (GFCE) grew at a massive 19.9% in year-on-year terms in the previous quarter.
A closer examination of the figures shows that the government has been using some sort of a counter-cyclical fiscal policy to stimulate investment activity.
Government spending is increased when investment starts going down and the stimulus is withdrawn once the situation improves. Boost to government spending seems to have worked in reviving Gross Fixed Capital Formation (GFCF) which registered negative growth in previous three quarters.
It could be expected that the government would slow down on government spending for the good part of forthcoming fiscal year and then press on the gas as the 2019 elections come closer.
Prima facie, this looks like smart short-term macroeconomic management. At the same time, the long term policy challenge seems to be a daunting one. Share of GFCF is overall GDP has been declining gradually and it has fallen below the 30% level since last few quarters. Declining investment in an economy does not bode well for future economic growth or initiatives such as Make in India. At a time when global economy is mired in uncertainty, sustaining India’s position at the global growth leader would not be sustainable without reviving long-term investment.