The currency swap initiative’s GDP surprise
The numbers could be revised lower as data from the informal sector is incorporated, but it is unlikely to change the underlying story
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The second advance estimate of national income for 2016-17 and data for the December quarter, released by the government earlier this week, has surprised most analysts. The estimates put out by the Central Statistics Office (CSO) showed that the Indian economy expanded at a rate of 7%, year-on-year, in the third quarter of the current fiscal, and is expected to grow by 7.1% for the full year. The second advance estimate was keenly awaited as the first advance estimate, released in January, did not capture the impact of the government’s currency swap initiative on economic activity.
While the output data has been revised for previous quarters, affecting the base for the third quarter, numbers put out by the CSO suggest that the currency swap didn’t have a significant impact on economic activity. Also, the CSO has not changed its full year gross domestic product (GDP) growth estimate of 7.1% for the current year despite an upward revision in last year’s growth. However, the estimate for gross value added (GVA)—the preferred indicator among economists—has been revised to 6.7% from 7% in the first advance estimate. Another way of looking at the data could be that GVA growth decelerated to 6.6% in the December quarter compared to 7% in the same quarter of the last fiscal. However, it is important to note that growth in the first two quarters of the current fiscal was also lower than comparable quarters of the last fiscal.
There could be several reasons why GDP growth has surprised on the upside. It is possible that the informal sector, which is largely cash dependent, would have been affected the most, but the impact has not been captured in the quarterly data. Nomura in its report, for instance, noted: “...the fact that the quarterly GDP statistics rely on organized sector data as a proxy for the unorganized sector may be one of the reasons for the divergence, as the organised sector was either unharmed or benefited from the shift in demand from the cash-intensive organized sector. Hence, the headline growth significantly masks the underlying slowdown.” It is likely that the numbers will be revised lower. However, it is unlikely to change the underlying story considerably: The currency exchange programme has had a limited impact on economic activity. The fact that opposition parties have not been able to make currency swap a political issue in the ongoing assembly elections also suggests that impact on the ground has been limited.
Another reason that could have played an important role is, contrary to popular public perception, that the entire exercise was managed well in terms of timing. It was announced after the festive season and thus did not affect consumption demand. In fact, private consumption has registered a sharp growth in the third quarter. On its part, the government also bumped up its own expenditure significantly during the quarter. Growth has also been supported by a sharp recovery in the agriculture sector after two years of drought. However, some commentators have insinuated that perhaps the data is being deliberately manipulated. Analysts and the public in general should avoid making such remarks as there is absolutely no reason for anyone to doubt the integrity of the CSO as an institution.
Overall, at a broader level, in the absence of revival in investment demand, economic growth continues to remain dependent on consumption expenditure. Even though gross fixed capital formation went up in the third quarter, its share in GDP has slipped below 30%. This should worry policymakers. Leveraged balance sheets in the corporate sector and stressed assets in the banking system are affecting investments to a large extent, with no real solution in sight.
In terms of monetary policy impact, the GDP numbers will not affect the policy stance of the Reserve Bank of India and market participants who were expecting a rate cut in the near term because of a considerable drop in economic activity will be disappointed.
Analysts are, naturally, busy interpreting the data and are waiting for more clarity to emerge in order to gauge the exact impact of the currency swap. Things will become clearer when the next estimate for the year and data for the fourth quarter is released in May. Given the full year estimate, growth in the fourth quarter is likely to be lower.
While there is now some clarity in terms of the cost of the currency exchange programme, it will be interesting to see the gains. In the short run, the success will be measured by the value of old currency notes that have not returned to the banking system. In the medium term, the increase in tax revenue and compliance will be the key indicators to watch.
What are the possible factors that pushed growth in the third quarter? Tell us at email@example.com