Yesterday (i.e. February 28, 2017), the Ministry of Statistics and Programme Implementation (MOSPI), published the quarterly estimates of the Gross Domestic Product(GDP) for October to December 2016.
As per this estimate, the GDP grew by 7 per cent for the October to December 2016 period, in comparison to the same period in 2015. In fact, MOSPI estimates that the Indian GDP for 2016-2017 will grow by 7.1 per cent.
What this tells us is that there has been almost no impact of demonetisation on economic growth (as measured by GDP growth), even during the period of October to December 2016, when demonetisation happened.
The question is how believable is this? One way of measuring the GDP is through the expenditure method. Under this method, the GDP is obtained by adding private consumption expenditure, government consumption expenditure, investments and net exports (imports minus exports). The private consumption expenditure forms a bulk of the GDP measured through this method.
The interesting thing is that the private consumption expenditure (at constant prices) for the October to December 2016, rose by 10.1 per cent, in comparison to the same period in 2015. This is the second fastest rise since June 2011. The data for the new GDP series adopted in January 2015 is only available up until then. GDP at constant prices essentially takes inflation into account.
Take a look at Figure 1. It shows the one year growth rate of private consumption expenditure, over the last five years.
Figure 1
The private consumption expenditure grew by 10.1 per cent in the October to December 2016 period. This, as mentioned earlier is the second fastest growth rate over the last five years. This seems unbelievable given that between November 9 and December 30, 2016, the currency in circulation had gown down dramatically, as Rs 500 and Rs 1,000 paper notes were demonetised and suddenly had no value.
Figure 2 shows this.
Figure 2
With the currency under circulation crashing, there wasn’t enough currency going around to carry out transactions. A bulk of the transactions in the Indian economy are carried out in cash. As per a PwC report cash/currency accounts for 98 per cent of consumer payments by volume in India. Take a look at Figure 3.
Figure 3
The Economic Survey of 2016-2017 points out: “The Watal Committee has recently estimated that cash accounts for about 78 percent of all consumer payments.” Hence, cash/currency accounts for bulk of consumer payments in India.
Demonetisation essentially rendered 86.4 per cent of the currency in circulation useless overnight. This made consumer transactions very difficult to carry out. While, the government did replace the money rendered useless with new money, but initially only Rs 2,000 notes made it to the financial system. These notes were very difficult to use because people found it difficult to give change, when almost no new Rs 500 notes were available. Hence, they were as good as useless for most of November and December 2016.
In this environment, how did private consumption expenditure grow by 10.1 per cent, the second fastest since June 2011, is a question worth asking?
One possibility is that people may have borrowed and bought things and in the process private consumption grew. Now take a look at Figure 4. It essentially shows the growth in retail loans given by banks between October and December across several years. Retail loans include loans given by banks to buy cars, two-wheelers, consumer durables, homes, credit card outstanding etc. They are a good measure of how robust the private consumption scene in the country is.
Figure 4
The growth in retail loans between October and December 2016 was almost flat at 0.5 per cent. This isn’t surprising given that most of the retail banking staff of banks was busy dealing with all the cash making it back to the banks because of demonetisation. What the figure also tells us is that the growth in retail loans between October to December 2016 has been the slowest in last five years.
Figure 4 clearly tells us that people did not borrow and spend between October and December 2016. So, the question is where did the growth in private consumption expenditure come about? One theory that has been offered is that many people bought a lot of gold using their old Rs 500 and Rs 1,000. The goldsmiths helped them by backdating their purchases.
This is one of those things that sounds to be true as soon as one hears it. But what does data tell us about this? India does not produce any gold of its own. If a lot of gold has been bought in this way, then the gold import numbers should go up in the months to come. The initial evidence on this front suggests otherwise.
Take a look at Figure 5.
Figure 5
Gold imports were high in November 2016 because of the festive season as well as the marriage season. And typically gold imports are high in November. If a lot of gold was bought by those who converted their black money held in the form of old Rs 500 and Rs 1,000 notes into gold, then gold imports should have picked up in December 2016 and January 2017, but they haven’t. They are considerably lower in comparison to December 2015 and January 2016. This basically puts the gold theory out of the window.
The other theory offered in explanation to private consumption expenditure going up has been that people bought a lot of iPhones after demonetisation was announced. How can the sale of one product push up GDP numbers is beyond my comprehension, but I will not get into that. While Apples sales did go up in October (pre-demonetisation) and November (eight days with no demonetisation), the sales crashed in December because of lack of cash in the financial system.
As a newsreport in The Economic Times points out: “After a cracker of sales in October-November, which heralded strong growth for that quarter, purchases of iPhones dwindled mainly because of the lack of cash, which had fuelled buying before demonetisation. That’s forced Apple to scale down its India revenue target to $2 billion for its fiscal year (October 2016-September 2017) from $3 billion.”
Also, the sales of many consumer goods companies fell during the period. (You can read about it here).
Essentially what all this tells us is that it is very difficult to believe that private consumption expenditure grew by 10.1 per cent during October to December 2016, despite demonetisation. There is something that clearly does not add up here. In fact, take a look at Figure 6. It shows what portion of the GDP is made up by private consumption expenditure.
Figure 6
As can be seen from Figure 6, the private consumption expenditure share in GDP is at very high levels. Also, the kind of jump seen between the period of three months ending September 2016 and the period of three months ending December 2016, has never been seen before.
And given that private consumption expenditure forms a bulk of the GDP, all in all, this tells us that there is something that just doesn’t smell right about India growing by 7 per cent in October to December 2016, when the currency situation was very tight.
The column originally appeared on Equitymaster on March 1, 2017.