The enigma around the GDP growth numbers has compounded, as it understated the impact of demonetisation. Eliminating the dissonance created by large revisions, nominal GDP growth in December quarter may have been impacted by 240 bp and 320 bp on a year-on-year and sequential basis, respectively.
The 7 per cent real GDP growth print for Q3FY17 released by the CSO on Tuesday gives an impression that the demonetisation shock did not have any impact on the economy. It has prompted many to conclude that the earlier grim assessment by many analysts may have been an over-reaction, with a critical bias on the entire demonetisation exercise.
The 7 per cent real growth is only modestly lower than 7.4 per cent in Q2 and somewhat higher than 6.9 per cent a year back. Growth in real gross value added (GVA), which now represents the activity-based GDP, grew at 6.7 per cent in Q3 compared with 6.7 per cent in Q2 and 8.2 per cent a year back.
While the new GDP series (base year 2011-12) has been an enigma since its inception, as it estimates growth numbers much higher than indicated by most industry-level leading indicators, the Q3 release has compounded the puzzle even more.
For instance, how can the economy grow at 12 per cent and 7 per cent in nominal and real terms, respectively, when the lending growth of banks has declined to a 60-year low of 5 per cent. Interestingly, the economy has also grown at this rapid pace with sustained absence of investments over the past 6-7 years, slowing trade, decelerating IT sector, while real estate construction remains in limbo for more than three years and without much job creation.
Likewise, manufacturing GVA has expanded 10.6 per cent in FY17YTD when manufacturing production growth has been contracting and the sector is facing considerably weak pricing power.
The Economic Survey 2016-17 provides some clue on the impact of demonetisation. For one, the true extent of cash reduction due to demonetisation was much lower than commonly perceived. Second, the shortfall in currency supply narrowed rapidly in December and thereafter. Presumably hence, the impact of the shock was much lesser than generally estimated.
The Survey went on to substantiate that the agriculture sector has not been impacted much, as the sowing area expanded in excess of 7 per cent YoY during the rabi season. Further, barring the real estate sector and two-wheelers, most other indicators such as excise duty collection, passenger car sales and credit growth normalised for other funding sources did not show much imprint of demonetisation.
The Survey concluded a broad range of impact of 25-100bp from its baseline FY17 nominal GDP projection of 11.25 per cent and 25-50 bp decline in real GDP from a baseline of 7 per cent.
Based on the data available till Economic Survey publication (ie prior to Q3 GDP release), its projected impact would have resulted in nominal GDP growth decelerating in H2FY17 to 10.7 per cent (with 25bp impact) or 9.3 per cent (100bp impact) compared to its baseline projection (ie if demonetisation did not happen) of 11.2 per cent for H2 of FY17.
Compared with these projections, CSO’s Q3 GDP release estimating nominal GDP growth of 10.7 per cent and advance estimate of 11.5 per cent for entire FY17 are far too strong. They imply H2 growth of 11.7 per cent, much higher than the best and worse-case H2 scenarios of 10.7 per cent and 9.3 per cent projected in the Economic Survey. Even the 10.7 per cent estimated for Q3 appears optimistic given the assumption that the impact of demonetisation was strongest during November-December 2016.
The implied growth for Q4 based on CSO’s latest advance estimates now stands at 12.7 per cent, i.e. highest since December 2013. Thus, against the backdrop of the sensitivity analysis done by the Economic Survey, which in my view is somewhat benign, the CSO’s advance estimates give an impression that the impact of demonetisation has been a puny little, and would be limited just to Q3 performance.
But that is just a statistical jugglery.
A lot gets revealed if we closely look at the significant revisions of past data in CSO’s estimates. The downwardly revised Q3FY16 nominal GDP growth of 8.7 per cent vs 9.1 per cent earlier, has created a beneficial base for Q3 of FY17. On the unchanged base, Q3FY17 nominal GDP growth would have been at 9.7 per cent instead of the reported 10.7 per cent. Hence, on an unchanged base, the deceleration in Q3FY17 has been a massive 240bp compared with an unrevised estimate of 12.1 per cent for Q2FY17 (Sep 2017 quarter).
Secondly, the reported 2.6 per cent sequential growth for Q3FY17, over the previous quarter (Q2FY17) is significantly lesser than the average seasonal rise of 5-6 per cent during Q3. Higher government spending, better monsoon in FY17 and strong festive demand would have implied a base case sequential rise of at least 6 per cent. Hence, on a sequential basis the reported 2.6 per cent QoQ growth is a slippage of at least 320 bp implying a loss of around Rs 1.2 lakh crore in nominal GDP, largely attributable to the demonetisation shock.
Hence, assuming GDP deflator for Q3FY17 at 3.2 per cent, real GDP growth for Q3FY17 on unchanged base would have been at 6.4 per cent compared with the reported 7 per cent and Economic Survey’s base case of 7.4 per cent (in absence of demonetisation). The 60bp decline in GDP deflator from 3.8 per cent in Q2FY17, despite continued rise in core inflation indicators also reflects the impact of demonetization on the horticulture sector (55 per cent of the agriculture GDP), where the cash withdrawal contributed to a sharp decline in price realizations and loss of margin for the overall farm sector.
Beyond just the GDP numbers, it is likely that the informal sector may have been impacted more severely due to demonetisation, as also acknowledged by the Economic Survey, and reflects in the sharp rise in demand for MNREGA jobs during Nov’16-Jan’17.
This partly explains the massive 42 per cent rise in allocation from Rs 33,000 crore in FY16 to Rs 47,000 crore revised estimate for FY17. Eventual allocation can be even higher as full impact of demonetisation on MNREGA has not been incorporated in the Union Budget 2017-18 statements, in my view.
Eventually, the relevance of the GDP numbers continues to remain challenged and the understatement of the demonetisation impact compounds it further. Eliminating the dissonance created by large revisions, the nominal GDP growth may have been impacted by 240bp on year on year basis and 320bp on sequential basis.
As the numbers for FY17 get further to incorporate informal sector components, the final numbers would indeed reflect the real impact of demonetisation. While the normalisation of the demonetisation shock and cyclical global recovery bode well for FY18, it is likely that fiscal policies will continue allocating more towards rural and farm sector and job creation.
As in earlier years, these imperatives will dilute the purported prudence of the Union and State government budgets.