The recent slowdown in India’s economic growth has raised serious concerns about the health of the Indian economy. Whereas the opposition has blamed demonetisationand government’s mismanagement of the economy as the key reasons for the slowdown, the government, though concerned about the situation, has attributed the economic slowdown to some temporary factors such as the disruptions caused by the new GST regime and sluggish world economy. Even within the ruling establishment voices which are critical of government’s handling of the economy are being raised for the first time since the Narendra Modi government has come to power. It seems Modi government is facing its toughest economic challenge ever.

Nature of slowdown

The growth rate of India’s Gross Domestic Product (GDP) has declined consistently for the last five quarters (Q) from 9.1% in 2015-16 (Q4) to 5.7% in 2017-18 (Q1) (Figure). Notably, the growth rate of 5.7% registered in 2017-18 (Q1) is the lowest since Modi government assumed office in May 2014. Except agriculture and allied sectors, all the other sectors namely manufacturing, construction and services have contributed to the economic slowdown. The growth rate of manufacturing sector has declined from 12.65 % in 2015-16 (Q4) to a mere 1.17% in 2017-18 (Q1). In case of construction sector, the growth rate has dropped from 6% to 2.01% during the same period. The services sector witnessed a dip in the growth rate from 10% in 2015-16 (Q4) to 6.9% in 2016-17 (Q3).

Reasons for slowdown

The fundamental reason for the decline in the economic growth rate after 2015-16 (Q4) is the significant decline witnessed in the growth rate of private investment. It declined from 8.3% in 2015-16 (Q4) to 1.6% in 2017-18 (Q1). On the contrary, public investment grew tremendously during the same period. This indicates that whatever growth we have achieved in the recent time is primarily due to a major push given to public investment. The growth rate of exports has improved notably from 2016-17 (Q1) as against the negative growth witnessed during the previous five quarters. Hence, poor export performance is not the reason for the recent growth slowdown.

A lot has been talked about on the impact of demonetisation. It is to be noted that the slowdown in economic growth has started even before the introduction of demonetisation on November 8, 2016, i.e. in 2016-17 (Q3) (Figure). However, demonetisation has proved to be a drag on an already slowing economy. This is evident from following trends: (i) the growth rate of private investment declined from 3% in 2016-17 (Q2) to 1.7% in 2016-17 (Q3) to -2.07% in 2016-17 (Q4); (ii) the growth rate of construction sector, which is considered to be most affected due to demonetisation, decelerated from 4.3% in 2016-17 (Q2) to 3.4% in 2016-17 (Q3) to -3.7% in 2016-17 (Q4) and (iii) the growth rate of Financial, Real Estate and Professional Services under services sector has declined from 7% in 2016-17 (Q2) to 3.3% in 2016-17 (Q3) to 2.2% in 2016-17 (Q4). However, in 2017-18 (Q1) the growth rate of private investment, construction sector and Financial, Real Estate and Professional Services has moved up to 1.6%, 2% and 6.4% respectively. This recovery might be due to remonetisation and hence suggests that the effect of demonetisation on the economy might be temporary.

Revival strategy

The options available before the government to revive economic growth are twofold.  First, as an immediate measure public investment has to be stepped up. Since there are no signs of a major recovery in the private investment this seems to be the best way out in the short run. It is argued that there is not much scope for further government spending in the rest of the year as a major portion of the fiscal deficit (i.e. government borrowing) target is already met. However, since the private investors continue to be reluctant to borrow money from banks and invest the same, the fear that high interest rates resulting from larger government borrowing would crowd out private investment is not valid in the present context. Also, since the banks are flushed with liquidity after demonetisation, the impact of government borrowing on cost of funds to private sector would be minimal. Hence, the government is now in a situation to breach the fiscal deficit target to a reasonable extent and incur additional public investment above what was budgeted. This opportunity has to be used. The government has already indicated its intention to re-assess its borrowing programme in December based on spending needs. Also, the government is said to be considering a stimulus package through higher capital spending to boost manufacturing and infrastructure.

Second, private investment is the key to sustained economic growth in a liberalised economy like India. Serious efforts have to be made to understand the reasons behind the recent stagnation in private investment on a sectoral basis and address them on priority basis. Interestingly, after Modi government has assumed office, private investment was growing strongly until 2015-16 (Q4). The free fall thereafter is perplexing considering the fact that the government has met some of the long pending demands of industry namely the passage of bankruptcy code, introduction of GST, and rationalisation of FDI rules. Surely, some other factors are at work here. Let me highlight two of them and possible solutions.

The ongoing efforts of the government to bring in a transparent and rule-based business environment through reforms such as brining more individuals and businesses under the tax net, emphasis on digital payments and cleaning up the bad loan problem might have generated a sense of uncertainty among the private investors thereby prompting them to play a wait and watch strategy before committing further investments. Therefore, the immediate priority before the government is to end the uncertainty and settled down to the new system at the earliest. Any delay on this front would slow down the growth engine further.

In our strategy to improve the investment climate, the emphasis given on the role of the state governments is inadequate. Today, economic conditions, business environment and governance at the state-level play a major role in attracting private investment. For instance, the primary responsibility of providing essential social and economic services such as basic education, health, sanitation and much of physical infrastructure that are very critical for the progress of business in the country rests with the state governments. Also, for India to achieve a high economic growth on a sustained basis, all states need to perform to their full potential by way of improving their economic governance. This suggests that the central government’s policies have its limits. Unfortunately, even after 25 years of economic liberalisation this thought is yet to percolate into the minds of the governments and policy makers. Unless the governance issues at the state level are addressed in a planned and coordinated manner, the dream of achieving and sustaining a growth rate of 8% would be hard to realise. In this regard, one wishes the centre and the states to replicate the spirit and cooperation they have demonstrated in implementing GST for the cause of building a ‘New economy for new India’.

(The author is Associate Professor of Economics at Indian Institute of Management, Kozhikode. He can be contacted at srn@iimk.ac.in. The views expressed are his own)