How Indian economy can recover from the disaster of demonetisation and GST

The buoyant mood of consumers is the only therapy to this excruciating slowdown.

 |  4-minute read |   12-10-2017
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The power of people is stronger than people in power. However, people in power often forget this and invite calamities. With the government and the banks exhausted post-demonetisation and GST, the revival of the Indian economy from a dangerous slide now depends entirely on the purchasing power of the people. Despite the double whammy of demonetisation and GST, consumers will have to take the shopping bags out to help the crumbling economy.

Free fall

India’s experiment with demonetisation that turned the fastest-growing economy into the fastest-slowing one has surprised many. Going by India's cash to GDP ratio (the amount of cash used in the economy), the enormity of growth slippage is just stunning.

India’s cash to GDP ratio of 12 per cent to 13 per cent before demonetisation was not so high that it could trigger such a free fall in growth, particularly when demonetisation was supported by a slow but consistent re-monetisation.

The reason behind the growth breakdown lies elsewhere, essentially in the withdrawal of people’s purchasing power. The GDP is the product of the “amount of currency in circulation” and “the velocity of currency”. With this formula, one can compute how much economic production (GDP) comes from the single note of currency.

The velocity of money, that is, the continual use of money is pretty interesting. A doctor pays Rs 100 to a taxi driver. The taxi driver buys his meal with that Rs 100. The eatery owner gets his mobile phone charged with the same, while the same money returns to neighbourhood doctor via mobile phone shop owner who pays his fees. By the time that Rs 100 makes its way back to the doctor, it has done a business of Rs 400.

In the complicated accounting of velocity of money, not only cash transactions but also bank transactions are reckoned with. Cash changes hands quickly, but payment or deposit via bank accounts moves slowly. In India, the velocity of money is nearly eight times faster than the currency flow. Every note is used seven to eight times in transactions.

The government can regulate the flow of the currency, but how many times a Rs 100 note (velocity) will be used is beyond its control. In other words, RBI can regulate the amount of currency in circulation but cannot control the GDP growth if the velocity is breaking up.


Note ban

The velocity of money is like a happy group dance (exactly like dandiya), where partners share their enthusiasm with each other. Velocity grows with purchase, consumption, and investment. This is the celebration of people's trust in the economy that pushes demand, drives investment and creates jobs eventually.

At times, governments conjure solutions that are more dangerous than problems. Just to smoke out some rodents of black money, poisonous gas of note ban was pumped in throughout the country. That resulted in currency and velocity going up in smoke, demolishing the GDP.

Currency has made a gradual comeback, but the after-effects of the toxic gas are so strong that consumers have lost all enthusiasm to spend.

Governments do not run economies. India’s GDP grows in direct proportion to people's enthusiasm. Personal consumption expenditure, in fact, accounts for 60 per cent of the GDP. People’s spending was soaring high during the years India kept recording high growth.

The GDP shrank after note ban because hundreds of millions of Indians controlled their spending. The crisis escalated after the launch of GST that put high taxation on key consumption.

Fuel price

The government, in all its sincerity, tried its best to boost demand by massive spending from the budget. The government spending accounted for over third (34.1 per cent) of the growth of the GDP in April-June quarter. However, there can’t be any alternative to the expenditure by millions of consumers.

The ever-increasing government expenditure is now at the risk of fuelling high fiscal deficit as the government has exhausted 92.4 per cent of the fiscal deficit target within the first four months (April-July) of the fiscal year 2017-18.

To quell the anxieties, finance minister Arun Jaitley may have promised some stimulus to the economy. However, going by the structural obduracy of the slowdown, neither cheap bank loans nor government spending nor foreign investment can salvage the faltering economy.

The government will have to think/act out of the box to boost consumption demand (recalibration of GST?) as existing trajectory of taxation on consumption (GST) coupled with rising fuel prices and benign growth is not at all conducive for a spurt in private consumption.

The buoyant mood of consumers is the only therapy to this excruciating slowdown. Would PM Modi like to give a call to people's (purchasing) power? Will people trust him and pick up their shopping bags again? Fingers crossed.

(Courtesy of Mail Today.)

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Anshuman Tiwari Anshuman Tiwari @anshuman1tiwari

Editor, economic analyst, columnist, author

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