New Delhi: The sharp slowdown in India’s economic growth to a three-year low at 5.7% in the June quarter of 2017-18 has forced the government to explore the need for a fiscal stimulus package while critics have pointed out the mishandling of the economy.

However, experts are now pointing out that misdiagnosing the ailment of the economy may lead to introducing wrong medicines which may further aggravate the situation.

One puzzle that the economy is facing is that while growth has slowed down to a three-year low at 5.7% in June quarter, current account deficit rose to a four-year high at 2.4% of GDP in the same quarter led by strong growth in manufacturing imports. But if demand is slowing, then why are imports accelerating?

Sajjid Z. Chinoy, chief India economist at JP Morgan offers a possible explanation. In a research note titled India’s growth slowdown: let’s get the diagnosis right, Chinoy says the surge in manufacturing imports started just after withdrawal of high value currencies in November last year.

“Imports contracted almost 5% in the year before demonetisation, in real terms. Since demonetisation, however, they have been growing at 13%," Chinoy says.

The increase in imports is across the board—gems and jewellery, electronics, paper, plastics and chemicals. “Stronger imports alone subtract 300 bps from headline growth – even after adjusting for imports that are re-exported. Therefore, stronger imports can explain the entire slowdown since demonetisation, and then some," he says.

Also read: How deep is India’s economic mess?

Furthermore, even as imports have surged, domestic production as shown by the industrial production data has stumbled and is lower than what should have been had the pre-demonetisation momentum sustained.

“What all this suggests is that domestic supply chains have potentially been disrupted in the manufacturing sector post-demonetisation – likely involving small and medium enterprises (SMEs) – and that activity has been replaced by imports. This also explains why imports began to pick up almost exactly around demonetisation despite slowing domestic demand," Chinoy says.

If this is entirely true, then an expansionary fiscal or monetary policy is unlikely to rehabilitate disrupted supply chains. “Instead, any increase in output will be at the cost of higher prices and external imbalances. Put differently, a fiscal stimulus – in the wake of an adverse supply shock – will simply stoke more imports and result in a larger current account deficit," Chinoy says.

Chinoy advocates that instead of a fiscal stimulus, government needs to introduce supply-side solutions to deal with supply-side shocks.

“We need to continue improving the regulatory and business environment for SMEs, improve their access to credit, urgently resolve teething Goods and Services (GST) problems and simplify the burdens of firms competing in the formal sector. More generally, we need to keep pushing hard on impaired asset resolution in the banking sector, so that the twin-balance sheet problem does not remain a binding constraint for larger investments," he adds.