The Economy is Finally Recovering from Ill Effects of Demonetisation - Vivek Kaul's Diary
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The Economy is Finally Recovering from Ill Effects of Demonetisation

Mar 1, 2018

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Finally, some goods news has started to stream in on the economic front. The gross domestic product (GDP) growth for the period October to December 2017, came in at 7.2%, the fastest in five quarters. But that is not why we, for a change, are writing something positive (as many of our readers keep asking for).

Take a look at Figure 1, which plots GDP growth as well non-government GDP growth, for the last few years. We get the non-government part of the GDP by subtracting government expenditure from it.

Figure 1:

There are two curves (well we can't call them lines, but is the term curve right for them?) in Figure 1. For a while, over the last year-year and a half, the blue curve was below the orange curve. This is by far the longest the blue curve has been under the orange curve, since 2014, a period of 4 years.

Now that is something very obvious if you look at Figure 1 carefully. But what does it really mean? The orange curve basically plots the GDP growth. The blue curve plots the non-government GDP growth. The non-government part of the GDP forms around 90% of the economy and for sustainable economic growth, this part of the economy needs to grow faster than the overall economic growth.

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It has now grown faster than the overall economy for the last two quarters. Between October and December 2017, it grew at 7.3% against overall GDP growth of 7.2%. Between July and September 2017, it had grown at 7%, against overall GDP growth of 6.5%.

For the period between January to June 2017, the non-government GDP growth, was a little over 4%. Indeed, this was very worrying. A rapid increase in government expenditure helped pump up GDP growth during that period. As we had said in our Letter back then, government expenditure driving GDP growth wasn't a sustainable idea, simply because the government only has so much money to spend. Beyond a point, excess government expenditure actually starts to hurt the economy. Also, in our Letters in November-December 2017, we had said that the Indian economy had started to revive a little. The latest GDP data just bears that out.

Now let's take a look at Figure 2, which is basically the same as Figure 1, but plots data from the beginning of 2016.

Figure 2:

Now take a look carefully at Figure 2. The blue curve came below the orange curve during the period October to December 2016, which is where it stayed for the next two quarters, only to recover during the period July to September 2017.

This happened primarily because of demonetisation which was announced on November 8, 2016. It killed a large part of the informal economy and impacted economic transactions in the formal part of the economy as well. With not enough cash going around in the economy, an economy built on cash transactions, had a tough time.

This pulled down the growth of the non-government part of the GDP. Demonetisation at its minimum level cost the country a period of nine months, in which the economic growth slowed down because of an ill-thought out government decision.

This is visible in Figure 3, which plots the GDP growth (in %) for the period between April to November, over the years.

Figure 3:

The economic growth a 6.44% between April to December 2017, has been the slowest in five years. This slowdown could have easily been avoided and happened primarily because of demonetisation. Going further, the Central Statistics Office has forecast a GDP growth of 6.62% in 2017-2018, which is the slowest growth in Narendra Modi's tenure as India's prime minister.

In fact, this is a great example of how the government in India interferes to hamper economic growth. We strongly feel that the decision making of any government in India should follow this basic rule: first do no harm. Everything else should follow this rule. But, alas that is not how things operate.

It needs to be stated here, this economic recovery, should not create the impression that all is well. The investment to GDP ratio (See Figure 4), having recovered from the worst, continues to be down in the dumps, at around 28-29% of the GDP. Without this picking up, the ability of the Indian economy to create both formal and informal jobs, so that people do not have to sell pakodas, remains rather limited.

Figure 4:

This malaise is also visible in Table 1, which basically shows that the investment projects continue to be down in the dumps.

Table 1:

In his budget speech the finance minister Arun Jaitley had said: "To carry the business reforms for ease of doing business deeper and in every State of India, the Government of India has identified 372 specific business reform actions. All States have taken up these reforms and simplifications in a mission mode constructively competing with each other."

For the investment climate to improve these reforms need to be implemented quickly. Let's see how this plays out.

Stay tuned!

Regards,
Vivek Kaul
Vivek Kaul
Editor, Vivek Kaul's Diary

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Vivek Kaul is the Editor of the Diary. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

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2 Responses to "The Economy is Finally Recovering from Ill Effects of Demonetisation"

satish dabholkar

Mar 1, 2018

Vivek Kaul was making comment not as economist on the subject of demonetisation.When money supply is reduced due to demonetisation,economic activity will come down but its benefits will start occuring after some period.
As ordinary student of commerce I was aware of this law but Mr Kaul was not aware was surprising.
Pl act and write as Economist in future and you will get correct results

Like (1)

Swapan PURKAYASTHA

Mar 1, 2018

If only there had been no opposition to digitisation and Jan Dhan Yojna .... like some villages didn't feel the pinch of Demonitization. CORRUPTION always opposes Development ... With attack and attach of illeagality will generate unemployment !

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