India's growth record is a puzzle

India’s economy grew at an average of 7.4 per cent during the five years of the National Democratic Alliance (NDA) regime, 2014-19. This compares favourably with United Progressive Alliance II’s (UPA II’s) record of average growth of 6.7 per cent. 

The average in the NDA regime tells us little about how growth actually came about.  The highest growth in the period — of 8.2 per cent — happened in 2016-17, the year of demonetisation. Growth of 7.2 per cent in the year that followed, 2017-18, defied forecasts that were closer to 6 per cent. In planning for the year ahead, policymakers used growth estimates for the current year that came to be significantly revised later. They were thus operating on the wrong premises. Nevertheless, growth happened. 

Let us begin with the first year of the NDA regime, 2014-15. The previous year’s Economic Survey had forecast growth of under 6 per cent in 2014-15. In January 2015, when the base year was changed from 2004-05 to 2011-12, the advanced estimate for growth for 2014-15 galloped to 7.5 per cent! The Survey of 2014-15 forecast growth in 2015-16 at 8.1-8.5 per cent. This forecast was eventually proved right — growth came in at 8.0 per cent in the final estimates. 

However, this was not the basis on which the Survey of the next year, 2015-16, worked.  The Survey of 2015-16 used growth estimates of 7.2 per cent for 2014-15 and 7.6 per cent in 2015-16.  The Survey forecast growth of 7-7.75 per cent for the following year, 2016-17. It had estimated India’s growth potential at 8 per cent plus. The estimate for 2015-16 and the forecast for 2016-17 would thus have meant that there was scope for fiscal and monetary stimulus. The reality was that the economy was moving towards its growth potential on its own.   

In 2016-17, economic policymakers faced an even more serious handicap: Lack of information about the intentions of the political authority. Demonetisation, announced on November 8, 2016, was not factored into the policymakers’ calculations. But this turned out to be far less of a problem than might have supposed.

Growth came in at 8.2 per cent in 2016-17, at least half a percentage point above the Survey’s forecast despite the impact of demonetisation on five months in the financial year. How did this miracle come about? The answer is provided by the quarterly gross domestic product (GDP) figures.  We know from the revisions to GDP figures effected in February 2019 that in Q4 of 2015-16, growth had touched 9 per cent. 

In Q1 and Q2 of 2016-17, GDP growth was 9.2 and 8.7 per cent respectively, more than one percentage point above the Central Statistics Office’s (CSO’s) estimates at the time.  The impact of demonetisation was felt in Q3 and Q4 of 2016-17. But it was not the only factor impacting growth adversely. Net exports had turned strongly negative in Q3 of 2016-17. GDP growth dropped to 7.4 per cent on account of both these factors. It fell further to 6.8 per cent in Q4 2016-17. 

We can now understand why GDP growth in 2016-17 was as high as 8.2 per cent despite the impact of demonetisation. When demonetisation was announced, the economy was growing at 9 per cent. As a result, growth remained at a high level even after factoring in the loss due to demonetisation.  If you thought that the economy was growing at around 7.5 per cent prior to demonetisation, as the Survey did, the growth rate of 8.2 per cent in 2016-17 would certainly have come as a huge surprise.

In forecasting growth of 2017-18, the Survey used an estimate for growth in 2016-17 of 7.1 per cent.  It projected growth at 6.7-7.5 per cent for 2017-18- or roughly the same level of growth as in 2016-17. We now know that growth in the year fell by a whole percentage point relative to 2016-17! This was mainly on account of a large, negative contribution from exports. The Survey’s forecast had assumed a boost to exports. GDP grew at 7.2 per cent in 2017-18. This was in the range forecast by the Survey. But it happened for reasons quite different from what the Survey had assumed.

In making its forecast for 2018-19, the Survey was guided by the estimated growth in 2017-18 of 6.75 per cent. It forecast a pick-up in growth to 7-7.5 per cent in 2018-19. Following the revisions made in February 2019, we know that was a slight deceleration in growth from the previous year. Growth is within the range forecast by the Survey but, again, for very different reasons. It is as though a blind person had been firing at a target — and hit pretty close. 

India’s average growth over the past five years of 7.4 per cent is remarkable given that it happened during a banking crisis. However, it is something of a puzzle. It cannot be ascribed to fiscal, monetary or exchange rate decisions taken by policymakers. The decisions were based on assumptions about underlying growth that were quite wrong. The growth record is best ascribed to structural reforms, the many that happened before the NDA government assumed office and the ones during its tenure. 

The writer is a professor at IIM Ahmedabad. ttr@iima.ac.in