Working Paper No. 2018-01

Arvind PanagariyaColumbia University

India: Three and a Half Years of Modinomics

The author is a Professor of Economics and Jagdish Bhagwati Professor of Indian Political Economy in the School of International and Public Affairs at Columbia University. Between January 2015 and August 2017, he served as the founding Vice Chairman of the National Institution for Transforming India or NITI Aayog, Government of India in the rank of a Cabinet Minister. The Prime Minister serves as the Chairman of the NITI Aayog, which replaced the erstwhile Planning Commission on 1st January 2015.

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TableofContents

1 TheLegacy............................................................................................................................................2

2 TheTurnaround.................................................................................................................................6

3 ProcessandPolicyReform............................................................................................................8

3.1 TacklingRetrospectiveTaxation........................................................................................9

3.2 EndingBureaucraticParalysis.............................................................................................9

3.3 EaseofDoingBusiness.........................................................................................................10

3.4 FDILiberalization....................................................................................................................10

3.5 ClosureandPrivatizationofPublicSectorEnterprises(PSEs)...........................11

3.6 ExitPolicy...................................................................................................................................12

3.7 DirectandindirectTaxReform.........................................................................................12

3.8 ReductioninPetroleumSubsidies...................................................................................13

3.9 DirectbenefitTransferusingAadhaar-basedVerification...................................14

3.10 Cooperative,CompetitiveFederalism.........................................................................14

3.11 AssaultonCorruption.........................................................................................................15

3.12 EaseofAccesstoServicesforCitizens........................................................................16

3.13 EndingOpenDefecation:TheSwachhBharatMission........................................17

3.14 Budget-relatedReforms....................................................................................................18

4 CriticismsandResponse...............................................................................................................19

4.1 GrowthisSlowerThantheCSOEstimates...................................................................19

4.2 GrowthhasbeenJobless......................................................................................................24

4.3 Demonetization........................................................................................................................28

5 ConcludingRemarks.......................................................................................................................32

India:ThreeandaHalfYearsofModinomics

ArvindPanagariya1

InMay2014,anewgovernmentledbyPrimeMinisterNarendraModitook

officeinIndia.Inthreedecades,thiswasthefirstgovernmenttowinanabsolute

majorityintheLokSabha,theLowerHouseoftheparliament.Itwasalsothefirst

timeinIndia’shistorythatthewinningcandidatehadcontestedthenational

electionpredominantlyontheplatformofeconomicdevelopment.“SabkaSaath,

SabkaVikas,”whichtranslatesas“CollectiveEffort,InclusiveDevelopment,”wasthe

catchphraseModiusedtocapturetheimaginationofthevoters.

AfterthreeandahalfyearsunderwhathascometobecalledModinomics,

wheredoestheIndianeconomystand?AlthoughIndianprintandelectronicmedia

ceaselesslyrundebatesondifferenteconomicissues,welackaunifiedaccountand

assessmentoftheprogressmadebythegovernment.Thepresentpaperattempts

tofillthiscriticalgap.

InSection1,Ibeginwithabriefaccountoftheeconomyfollowingthe1991

economicreformswithspecialattentionpaidtoitsstatejustbeforetheModi

governmenttookoffice.InSection2,Idiscusstheoverallperformanceofthe

economyincludingtheGDPgrowth,macroeconomicdevelopmentsandprogressin

attractingforeigndirectinvestment.InSection3,Iofferanaccountofthekey

processandpolicyreformsintroducedbythegovernment.Thediscussionhere

1TheauthorisaProfessorofEconomicsandJagdishBhagwatiProfessorofIndianPoliticalEconomyintheSchoolofInternationalandPublicAffairsatColumbiaUniversity.BetweenJanuary2015andAugust2017,heservedasthefoundingViceChairmanoftheNationalInstitutionforTransformingIndiaorNITIAayog,GovernmentofIndiaintherankofaCabinetMinister.ThePrimeMinisterservesastheChairmanoftheNITIAayog,whichreplacedtheerstwhilePlanningCommissionon1stJanuary2015.

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showsthatthishasbeenaveryactivegovernment,seekingchangeinwidevariety

ofareas.InSection4,Iassessthecriticismsofthegovernmentinthreekeyareas:

lackofrobustnessofgrowth;poorrecordofjobcreation;andilleffectsof

demonetization.InSection5,Iconcludethepaper.

Attheoutset,Imaynotethatwhilethisisperhapsafulleraccountofthe

threeandahalfyearsoftheModigovernmentthanavailableelsewhere,itisfar

fromcomplete.Inparticular,toensurethatthepaperisnotundulylong,Ihave

deliberatelyleftouttheareasofinfrastructure,energy,agriculture,innovation,

entrepreneurship,skilldevelopmentandsocialsectors.Majordevelopmentshave

takenplaceineachoftheseareasbuttheircoveragemustawaitaseparatepaper.

1 TheLegacy

Theyear1991wasawatershedyearintheeconomichistoryofIndia.That

year,thecountrydiscardeditsfour-decade-oldcommand-and-controlmodelin

favorofapro-marketdevelopmentstrategy.Tobesure,thereformpackage

includedsomeboldreforms.Forexample,inonestroke,itputanendtoinvestment

licensingunderwhichanysignificantprivateinvestmentrequiredalicense

specifyingtheproducttobeproduced,itsquantityandthelocationatwhichitwill

beproduced.Similarly,iteliminatedtheimportquotaregimeexceptinthecaseof

finalconsumergoodsunderwhichimportofaproductrequiredobtainingalicense

specifyingthequantityoftheproductallowedtobeimported.Thereformpackage

alsogenuinelyopenedthedoortoforeigninvestment,whichhadhithertobeen

permittedunderextremelystringentconditionsasaresultofwhichhardlyany

foreigninvestmentcameintothecountry.

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Thesemajorreformsinthe1991packagenotwithstanding,theshiftfromthe

state-ledtoquasi-market-leddevelopmentwasgradualandspreadovermorethan

adozenyears.Theexistenceofmultiplelayersofregulationineveryconceivable

areaofpolicyandmyriadbureaucraticcontrolscoupledwithIndia’scontentious

democraticpolitymeantthatittookseveralyearsofsustainedefforttoputinplace

reformsnecessarytogeneratesignificantsupplyresponse.The1990sandearly

2000ssawmanyofthesereformstakeroot.Asaresult,beginninginfinancialyear

2003-04,Indiafinallytransitedintoan8%plusgrowthtrajectory.2Fornineyears

from2003-04to2011-12,therealGrossDomesticProduct(GDP)ofthecountry

grewattheannualrateof8.2%.3

ThebulkofthereformsthatpropelledIndiaintothishighgrowthtrajectory

wereundertakenunderPrimeMinistersNarasimhaRaoandAtalBihariVajpayee.

Theformerservedfrom1991to1996andthelatterfrom1998to2004.Ihave

providedadetailedaccountofthesereformsinmy2008book,India:TheEmerging

Giant.Inanutshell,thereformsincludedopeningtheeconomytoforeigntradeand

investment;fullcurrent-accountconvertibilityoftherupeemeaningforeign

exchangeforimportsofgoodsandserviceswasmadefreelyavailable;substantial

liberalizationofthecapitalaccountmeaningthatforeigninvestorscouldinvestin

IndiathroughavarietyofinstrumentsandIndianinvestorscouldborrowfunds

abroadmorefreely;endtoinvestmentlicensing;allowingentryofprivate

2DatainIndiaarereportedaccordingtoitsfinancialyear,whichbeginson1stAprilandendson31stMarch.Therefore,financialyear2003-04referstotheperiodfrom1stApril2003to31stMarch2004.3GDPfiguresinthispaperrefertowhatisreportedastheGDPatmarketpricesintheofficialstatistics.Untilrecently,IndiareportedtheGDPatfactorcostasitsofficialGDP.Butrecently,ithasswitchedtothepracticeofreportingGDPatmarketpricesasitsofficialGDPasrecommendedbytheUnitedNationsSystemofnationalAccounts.

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companiesininsurance,telecommunicationsandcivilaviation,whichhadbeen

publicsectormonopoliesinthepast;acceleratedentryofprivateIndianandforeign

banksinasectorotherwisedominatedbypublicsectorbanks(PSBs);shiftfrom

controlledtomarket-determinedinterestrates;substantialrationalizationofdirect

andindirecttaxes;privatizationofselectedpublic-sectorenterprises(PSEs);entry

tolargeenterprisesinnumerousproductspreviouslyreservedforexclusive

manufacturebysmall-scaleenterprises;andanewcompetitionpolicy.

InMay2004,BharatiyaJanataParty(BJP)governmentofPrimeMinister

VajpayeeunexpectedlylosttheparliamentaryelectiontoCongress-ledUnited

ProgressiveAlliance(UPA).TheUPAservedinofficefortenyearsuntilMay2014.

Duringthesetenyears,pro-marketreformsreceivedamajorsetback.Tobesure,

UPAdidtakesomehalf-heartedmeasuresqualifyingasreformsduringitsfirstfive-

yeartermbutitentirelyabandonedtheminthesecondterm.Itcametotakehigh

growthforgrantedandturnedcomplacent.Itchosetogoforseveralpopulist

measuresthatproveddetrimentaltosustainingthehighgrowth.

Prominentamongthesemeasureswereretrospectivetaxation,whichgreatly

underminedinvestorconfidence;recklesslendingbyPSBsonprojectsofdubious

value,whicheventuallyledtogreatweakeningoftheirbalancesheets;Land

AcquisitionActof2013,whichmadefuturelandacquisitionimmenselycostlyand

procedurallycumbersome;andsystematicdenialofenvironmentalclearancesto

majorinfrastructureprojects,whichdirectlyunderminedgrowth.Breakoutof

multiplecorruptionscandalsandgeneralparalysisindecision-makinginthecentral

governmentreinforcedtheilleffectsofthesemeasures.Poormanagementofthe

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exchangerateand13successiveinterest-ratehikesbytheReserveBankofIndia

(RBI)addedfueltothefire.

Between2004-05and2007-08,fiscaldeficitofthecentralgovernmenthad

beenhelddownbetween2.5to4%oftheGDP.Thisfiscaldisciplinewaslostinthe

subsequentyearswiththedeficitescalatingto4.5to6.5%oftheGDPbetween

2008-09and2012-13.Initially,in2008-09,populistelection-yearspendingsuchas

farmloanwaivers,hikesinsalariesofgovernmentofficialsandtheextensionofa

ruralemploymentguaranteeschemefrom200poorestdistrictstotheentire

countryraisedthedeficitto6%oftheGDP.Subsequently,ratherthanreturnto

fiscaldiscipline,thegovernmentchosetomaintainhighexpendituresonthepretext

thatitwasnecessarytocombatilleffectsoftheglobalfinancialcrisis.Inreality,by

late2009,growthestimateswerealreadyshowingsignsofasteadyrecoveryin

growthmakingthefiscalexpansionunnecessaryandundesirable.

Predictably,thesepolicymistakeshadseriousnegativeeffectsonthe

economy.Beginninginthethirdquarterof2010-11,growthratefellforsix

consecutivequarters.Withstructuralweaknesseshavingpenetratedtheeconomy

deeply,evenafterbottomingoutinthefirstquarterof2012-13,growthdidnot

recoverinarobustmanner.BasedontheoldGDPseriesinuseatthetime,the

averageGDPgrowthfellto4.9%during2012-13and2013-14,thelasttwofinancial

yearsoftheUPA.Later,whenIndiashiftedtothenewGDPseries,thisfigurewas

revisedupwardto5.9%.

Amajorhikeinoilpriceinthesummerof2008andexpansionaryfiscal

policytranslatedintodouble-digitinflationfrom2008-09to2013-14.Alongside,

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thecurrent-accountdeficit,whichmeasuresthedifferencebetweenimportsand

exportsofgoodsandservicesadjustedforremittances,balloonedto4.3%in2011-

12and4.8%in2012-13.WiththeRBIhavingabandonedthelongstandingpolicyof

managingtheexchangerateandcapitalinflowsbeingprogressivelyliberalized,the

UnitedStatesdollarappreciated26%againsttherupeeduringtheelevenmonths

endingon31stAugust2013.

ThattheeconomywasslidingdownrapidlywasbecomingapparenttoIndia

watchers.Referringtotheslowingeconomicgrowthandpoliticalroadblocksto

policymaking,theStandardandPoorrhetoricallyaskedinthetitleofa2012report,

“WillIndiaBetheFirstBRICFallenAngel?”Inasimilarvein,citingalarming

macroeconomicindicators,anAugust2013storyintheEconomistconcluded,“Itis

widelyagreedthecountryisinitsworsteconomicbindsince1991.”

2 TheTurnaround

Itwasunderthesedifficulteconomiccircumstancesthatthepresent

governmenttookoffice.Itsimmediatechallengewastorestoremacroeconomic

stabilityandaccelerateGDPgrowth.Goingbytheavailableestimatesofvarious

indicators,thegovernmentsubstantiallymetthischallenge.Whilethescopefor

additionalgrowthaccelerationremains,aninitialturnaroundhassurelybeen

achieved.

Duringthethreefullfinancialyearsfrom2014-15to2016-17,theGDPhas

grownattheannualaveragerateof7.5%.Thisis1.6-percentagepointshigherthan

therateduringthelasttwoyearsoftheUPA.Itisalsothehighestamongthemajor

economiesoftheworld.Forthefirsttime,IndiahassurpassedChinaintermsof

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GDPgrowththough,admittedly,itremainsfarbehindthelatterintermsofthe

levelsofGDPandper-capitaGDP.

Inadditiontoachieving7.5%growth,Indiahasalsoseenthereturnof

macroeconomicstabilityduringthelastthreeyears.Inspiteofcontinuous

pressuresforlargeincreasesinexpendituresbyconstituencieswithinaswellas

outsidethegovernment,thelatterhasstayedcourseonitsfiscalconsolidationplan.

From4.5%oftheGDPin2013-14,ithasbroughtfiscaldeficitsteadilydownto3.2%

in2017-18.Therehavebeennoreversalsalongtheway.

Earlyinitstenure,thegovernmentadoptedatargetof4%inflationas

measuredbytheConsumerPriceIndex(CPI)with2-percentagepointvariationon

eithersideofthistargetpermitted.Withthistargetatthecenterofmonetary

policy,theReserveBankofIndia(RBI)hassuccessfullybroughtinflationdown.It

hadstoodat10.1%in2012-13and9.3%in2013-14.Duringthethreeyearsofthe

presentgovernment,theratehasbeensuccessivelybroughtdownto5.9%,4.9%

and4.5%.

Thecurrentaccountdeficithadalsobeenhighat4.3%oftheGDPin2011-12

and4.8%in2012-13,thoughitdidcomedownto1.7%in2013-14underUPA.This

importantindicatorhascomefurtherdownto1.3%,1.1%and0.7%insuccession

duringthethreeyearsofthepresentgovernment.Thenominalexchangeratehas

beenrelativelystablewithforeignexchangereservesrisingfrom$312billionin

May2014to$380billioninMay2017.

Foreigninvestorshavereactedfavorablytotheimprovedeconomic

environment.Totalforeigndirectinvestment(FDI)hasrisenfrom$36billionin

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2013-14to$45billionin2014-15,$56billionin2015-16and$60billionin2016-

17.Thesefigurescomparewith$118billionworthofFDIin2016intoChina,which

isnowfivetimestheIndianeconomyintermsoftheGDP.Therefore,intermsof

FDIasaproportionoftheGDP,IndiahasmovedwellaheadofChina.

3 ProcessandPolicyReform

NoteveryoneagreeswiththispositivenarrativeoftheModiyears.Indeed,

polarizeddebatesonthegovernment’spoliciesandaccomplishmentscanberead

eachmorninginIndiannewspapersorviewedeacheveningontheIndian

television.Thelatestofthesedebateswastriggeredbyadeclineinthegrowth

duringthefirstquarteroffiscalyear2017-18to5.7%.Iwillreturntosomeofthe

moreimportantofthesedebatesbelowinSection4.

Presently,inthissection,Idocumentthemajorprocessandpolicyreforms

thatthegovernmenthasundertaken.Whilesomeofthesereformshaveyielded

immediatereturnstowardsraisingtheaverageGDPgrowthduringthefirstthree

yearsto7.5%,theimpactofothers,especiallythoseofstructuralnature,willbefelt

onlyafterthreetofiveyears.India’sownexperiencetestifiestothelonglags

betweentheintroductionofstructuralreformsandtheirfullimpactonthe

economy.

Asalreadynoted,toensurethatthepaperisnotoverlylong,thediscussion

ofprocessandpolicychangesinthispaperisnotexhaustive.Inparticular,it

excludesareassuchasofinfrastructure,energy,agriculture,innovation,

entrepreneurship,skilldevelopment,educationandhealth.

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3.1 Tackling Retrospective Taxation

Theimmediatetasksbeforethegovernmentupontakingofficewereto

reassureinvestorsandendtheparalysisinthegovernment.4Duringthelasttwo

yearsoftheUPArule,investors,especiallyofforeignorigin,hadbeenreelingunder

thefearofretrospectivetaxation.In2012,theUPAgovernmenthadamendedthe

IncomeTaxActof1961soastoempowerittoassesslargesumsoftaxesgoingback

severalyearsoncompanies.Thishadleftforeigninvestorsverynervous.

Therefore,oneoftheearlyactsofthegovernmentwastoassurethese

investorsthatnonewcasesunderthelawwouldbeopenedup.Incasesthathad

alreadybeeninitiatedbytheUPA,thegovernmenttookthejudiciouspathofnot

pursuingthemfurtheroncetheHighCourtruledinfavorofthedefendant.The

resulthasbeenmuchmorepredictableinvestmentclimateinsofarastaxationis

concerned.ThechangehasbeeninstrumentalinacceleratingthegrowthofFDIin

India.

3.2 Ending Bureaucratic Paralysis

Thegovernmentalsotookearlystepstoendtheparalysisindecision-making

processthatithadinherited.Environmentalclearanceswerespeededupandthe

PrimeMinisterassuredofficersthattheycouldtakedecisionswithoutthefearof

beingchargedwithwrongdoing.Healsointerveneddirectlytoimprove

coordinationamongdifferentministries.Heestablishedasystemwherebythekey

ministryhandlingaparticularissuemakesapresentationtohimwiththetop

4InanarticlepublishedinthisJournalsoonaftertheModiGovernmenttookoffice,Ihadwrittenthatendingretrospectivetaxationandbureaucraticparalysiswereamongstepscrucialtojumpstartingtheeconomy.SeePanagariya,Arvind,“ThePromiseofModinomics,”ForeignAffairs,10thJune2014.

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bureaucratsoftheotherrelevantministriespresent.Thisallowshimtosortout

manyinter-ministerialissuesonthespot.ThePrimeMinisteralsoworksona

regularbasiswiththestateChiefSecretariestoclearhurdlesfacingmajorprojects.

Thisapproachhasaccelerateddecision-makingatthecenterandhelpedunblocka

largenumberofstalledprojects.Forexample,roadministryhasseen66ofthe73

stalledprojectsithadinheritedfromthepreviousgovernmentgettingresolved.

3.3 Ease of Doing Business

Thegovernmenthasplacedspecialemphasisonimprovingtheeaseofdoing

business.Ithasworkedcloselywithstatestocutredtapeinareasuchasstartinga

business,issuanceofconstructionpermits,gettingcredit,protectingminority

investors,payingtaxes,enforcingcontractsandresolvinginsolvency.Theresulthas

beenmuchimprovedbusinessenvironmentwithIndiamovingfrom142ndto100th

positionbetween2014and2018intheWorldBank’seaseofdoingbusiness

rankings.Indeed,businessenvironmentintheleadingstatessuchasAndhra

PradeshandGujaratisfarfriendlierthanreflectedinthisrankingsincetheWorld

BankcollectsallitsdatainDelhiandMumbai,whichranklesshighlythanthese

statesintheGovernmentofIndia’sstate-levelrankingsdoneaccordingtocriteria

similartothoseusedbytheWorldBank.

3.4 FDI Liberalization

Whenthegovernmentcametooffice,foreigninvestors,especiallythosefrom

theUnitedStates,consideredahikeintheFDIcapininsurancefrom26%to49%as

thelitmustestofitswilltoreform.Thegovernmenthasnotonlydeliveredonthis

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reformbutgoneontoopenothersectorstoforeigninvestorsaswell.Itopened

defensetoforeigninvestorsfirstsettingthecapat26%andthenraisingitto49%

throughautomaticrouteand100%throughapprovalroute.Thegovernmenthas

alsopermitted100%FDIinmarketingoffoodproductsproducedinIndia;high-tech

andcapital-intensiveactivitiesintherailways;coffee,rubber,cardamom,palmand

oliveplantations;manufacturingofmedicaldevices;e-commercemarketplace;and

non-bankautomatictellermachines.

3.5 Closure and Privatization of Public Sector Enterprises (PSEs)

Afteralagofmorethanadecade,thegovernmenthasinitiatedaprogramof

closureofsickPSEsandprivatizationofthosePSEsthatdonotserveapublic

purpose.ManysickPSUshavebeenentirelywithoutanyproductionactivity

whatsoeverandyethavebeenkeptalivebytheirrespectiveministries.Assuch,

theyhavebeenanetburdenontheexchequer.Theprocessoftheirclosureis

complicatedduetodifficultiesinthedisposalofthelandtheyown.Nevertheless,

morethanadozenPSEsarenowinadvancedstagesofclosure.Ontheprivatization

front,theCabinethasapprovedthreelistsofenterprisesforstrategicsalesandput

evenAirIndiaontheblock.Unfortunately,however,keybureaucratsinthe

MinistryofFinancehavebeenslowinmovingtheprocessforward,duetowhichno

finalsaleshavetakenplaceasyet.Buttransactionsadvisershavebeenappointed

foranumberofPSEsanditisonlyamatteroftimethatoutrightsalesofPSEswill

beseentakingplace.

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3.6 Exit Policy

Ihavewrittenformorethanadecadethattheprocessofexitoffirms,

especiallylargeones,isextremelycomplexandtimeconsuminginIndia.Winding

upoffirmsnormallytakesmorethanadecadeanditisnotunusualfortheprocess

todragfortwodecadesorlonger.Thisdifficultyofexithasseriousimplicationsfor

entryofnewfirms.Giventhehighexitbarrier,potentialentrantsenterbusiness

onlywhentheyarenearlycertainthattheywouldsurvive.Thepresentgovernment

hasfinallyenactedtheInsolvencyandBankruptcyCodeof2016,whichallows

windingupoffirmsinatimeboundfashionmuchlikethebankruptcylawinthe

UnitedStates.Thislawisnowbeingusedtobringtoclosuremanyofthenon-

performingassetsofthepublicsectorbanks.

3.7 Direct and indirect Tax Reform

Therehasbeenprogressinreformingbothdirectandindirecttaxes.The

lowestdirectpersonaltaxratehasbeenreducedfrom10to5%withtheviewto

discouragepotentiallow-endtaxpayersfromevadingtaxpaymentandthusexpand

thetaxbase.Acommitmenthasalsobeenmadetobringthecorporateprofittax

downto25%from30%.Thischangehasalreadybeenputintopracticefor

companieswithturnoverbelow500millionrupees.

Ontheindirect-taxfront,theGoodsandServicesTax(GST)arguably

representsthemostimportantandpoliticallydifficultreforminIndiato-date.It

tookmorethanadecadeofeffortsbythreedifferentgovernmentstocompleteand

requiredaConstitutionalamendment,severallegislationsandconsensusamong29

statesandthecentralgovernment.ForthefirsttimeinIndia’shistory,anygiven

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commodityorserviceissubjecttoasingletaxratenationally.TheGSTreplaces

numerousstateandcentraltaxbyasingletax.Thismeansthatvehiclesmoving

goodsfromonestatetoanothernolongerhavetobestoppedattheborderfortax

relatedmatters.Thoughithasbeenwidelycriticizedforitsvariegatedstructure

acrossdifferentcommoditiesandservicesandforpoorimplementation,itremainsa

majoraccomplishmentofthegovernment.WithinthedemocraticpolityofIndia,no

majorreformiscompletedatonestroke.Forexample,tradereformwasspread

overnearlytwodecadesandstillremainsincomplete.ThesameappliestotheGST.

Withthemajorstepscompleted,amovementtofewerratesandbetter

implementationcanbeachievedintheyearstocome.Somemovementinthis

directionisalreadyunderway.

3.8 Reduction in Petroleum Subsidies

Thegovernmenthasmadeaconcertedefforttobringdownpetroleum

subsidies.Dieselandpetrolpriceswerefullydecontrolledfrom1stJanuary2015.

Thisonlyleaveskeroseneandcookinggassubsidiesaspetroleumrelatedsubsides.

Regardingcookinggassubsidy,thegovernmenthasbeenincreasingthepriceofgas

cylindersby4rupeeseachmonthwiththeviewthatthesubsidywillbeentirely

eliminatedbytheendofMarch2018.Therehasalsobeensubstantial

rationalizationofkerosenesubsidywithsomestatestakingmeasurestobecome

kerosenefree.Thetotalsubsidyandunder-recoveryonpetroleumproducts,which

hadstoodat$2.25billionin2013-14,camedownto$340millionin2015-16.5

5SeethepressnotebyPressInformationBureau,GovernmentofIndiadated25thApril2016andtitled“SubsidyonPetroleumProductsathttp://pib.nic.in/newsite/PrintRelease.aspx?relid=141145.

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3.9 Direct benefit Transfer using Aadhaar-based Verification

Amajorachievementofthegovernmenthasbeentorapidlyspreadthe

biometricidentityprogramstartedbythepreviousgovernmentandknownas

Aadhaar.Today,with1.1billionIndiansprovidedthisidentity,thecoverageis

almostuniversalexceptinthenortheasternstates.Thegovernmenthasbeen

graduallyspreadingtheuseoftheidentityinthedisbursementofsocialbenefitsvia

whatiscalledtheDirectBenefitTransfer(DBT)mechanism.Avastnumberof

CentrallySponsoredSchemesincludingsuchmajoronesasthesubsidyoncooking

gascylinders,saleoffoodgrainatsubsidizedpricesunderpublicdistribution

systemandpaymentofwagesundertheNationalRuralEmploymentGuaranteeAct

programarenowbeingimplementedthroughDBTmechanism.Biometric

verificationhasmeantthatmillionsofghostandduplicatecardsthatbeneficiaries

usedtoreceivebenefitsmultipletimesinthepasthavebeeneliminated.According

totheestimatesprovidedbythegovernment,savingsattributabletoDBT

mechanismamountedtonearly$9billionin2016-17alone.

3.10 Cooperative, Competitive Federalism

Thegovernmenthasalsobroughtaboutamajorchangeinthewaythe

centralgovernmentrelatestostates.Inthepast,thePlanningCommissionhad

exercisedconsiderableinfluenceovertheallocationofdevelopmentalexpenditures

ofthestatesthroughgrantsitgavethelatterfortheirstateplans.Acceptingthe

recommendationsoftheFourteenthFinanceCommission,thepresentgovernment

Ihaveconvertedtherupeefiguresinthepressnoteintodollarsusingtheexchangerateof65rupeesperdollar.

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replacedthesegrantsbyanincreaseintheshareofthestatesinthecentraldivisible

pooloftaxrevenuefrom32%to42%.Thischangegaveconsiderablefreedomof

expendituretothestates.

Alongside,thePrimeMinisteralsoreplacedthePlanningCommissionbythe

NationalinstitutionfortransformingIndiaorNITIAayogwithamarkedlydifferent

mandate.Asaresult,theNITIAayoghasbeguntoplayacatalyticrolein

intensifyingbothcooperationandcompetitionamongstates.Onthecooperation

front,itidentifiesthebestpracticessuchase-auctionofagriculturalproducein

Karnataka,evidence-basedpolicymakinginGujarat,schoolconsolidationin

RajasthanandspreadofbroadbandinAndhraPradeshforadoptionbyotherstates.

Onthecompetitionfront,ithasbegunpublishingoutcome-basedrankingsofstates

inareassuchaseducation,healthandwater.

Today,anintensehealthycompetitionmaybeseenamongchiefministersof

differentstatesindifferentareas.TheNITIAayoghasalsocatalyzedreformsatthe

levelofthestate.Forexample,ithaspilotedaModelLandLeasingAct,whichis

beingprogressivelyadoptedbydifferentstatestoreplacetheirantiquatedtenancy

lawsadoptedintheimmediateaftermathoftheIndependence.TheNITIAayoghas

alsopromotedthereformsinmarketinginagricultureandcontractfarming.These

areareasinwhichthestateshavetheexclusiverighttolegislate.

3.11 Assault on Corruption

InkeepingwiththepromiseofPrimeMinisterModiduringelection

campaign,thegovernmenthastakennumerousstepstocrackdownoncorruption

beginningwiththeappointmentofaSpecialInvestigationTeamonitsfirstday.

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Additionalstepsincludeenactmentofalawregardingundisclosedforeignincome

andassets;amendmentoftheDoubleTaxationAvoidanceAgreementswith

MauritiusandCyprus;developmentofanunderstandingwithSwitzerlandon

gettinginformationonbankaccountsheldbyIndiansincertaincases;amendment

oftheBenamiTransactionsAct;implementationoftheIncomeDeclarationScheme

2016;demonetizationwherebyhighdenominationnotesof500and1,000rupees

losttheirlegaltenderstatusovernighton8thNovember2016;andpost-

demonetizationinvestigationofindividualandcompanybankaccountsandtax

returns.

Atthecenter,thegovernmenthasensuredthatnobribesaretakeninthe

dischargeofnormalbusiness.Transparentauctionshavereplacedbureaucratic

allocationsofvariousresources.ThePrimeMinisterhimselfhasassuredpublic

sectorbanks(PSBs)thatunlikeundertheUPA,hisgovernmentwouldnotintervene

intheirlendingactivitiesinanyform.Theseeffortshavehadvisiblesuccess:

whereasonecorruptionscandalafteranotherhadrockedtheUPA,therehavebeen

noallegationsofhigh-levelcorruptionagainstthepresentgovernment.Whilethis

positiverecordiswidelyacknowledged,therehavebeenscathingcriticismsof

demonetization.Ishalldetailandevaluatethesecriticismslaterinthepaper.

3.12 Ease of Access to Services for Citizens

Thegovernmenthasalsotakenstepstoimprovethecitizens’accessto

publiclyprovidedservices.Ithasintroducedself-certificationofcopiesofdiplomas

anddegreeswhenapplyingforjobs.Inthepast,applicantshadtofindasenior

governmentofficeroraseniormemberofjudiciarytohavethecopiesoftheir

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diplomasanddegreescertified,arathercostlyaffairespeciallyforthoseresidingin

ruralareas.

Thegovernmenthasalsoprogressivelymovedtheprovisionofnumerous

publicservicesonlinetherebyeliminatingdirectcontactwithofficials,whichis

frequentlythesourceofpettycorruption.AdigitalapplicationcalledUmang

[UnifiedMobileApplicationforNew-ageGovernance]consolidatesnumerous

servicesdigitallyprovidedbycentral,stateandlocaladministrationsonasingle

platform.Currently,servicesprovidedby39entitiesincludingapplyingfor

passport;filingincome-taxreturns;payingvariousbills;accessinglandrecordsin

certainstates;accessinge-booksandeducationalaudiosandvideos;accessing

agriculturalextensionservices;andmakingappointmentsatgovernment-run

hospitalsareavailablethroughUmang.Governmenthasalsocreatedportal

DigiLocker,whichservesasadigitallockerserviceandenablescitizenstostore1

GBworthofofficialdocumentsonthecloud.Theserviceeliminatestheneedfor

carryingarounddocumentsinphysicalform.

3.13 Ending Open Defecation: The Swachh Bharat Mission

Thoughadiscussionofsocialprogramsofthegovernmentisbeyondthe

scopeofthispaper,thepapercannotaffordtoneglectmentioningbrieflythe

SwachhBharatMission(SBM).InhisfirstIndependenceDayspeech,PrimeMinister

NarendraModiannouncedthelaunchingoftheSBMbeginningon2ndOctober2014,

MahatmaGandhi’s145thbirthanniversary,andendingfiveyearslateronhis150th

birthanniversary.ThebroadagendaoftheSBMisastepjumpincleanlinessinall

itsaspectsinruralandurbanIndiabutitsmostimportantcomponentistheendto

18

opendefecation.Whileeffortstowardsendingopendefecationarenotnew,the

progressachievedundertheSBMisunprecedented.On2ndOctober2014,whenthe

missionwaslaunched,only38.7%ofruralhouseholdshadtoilets.By2ndOctober

2017,thisproportionhadreached71%.Thoughtheprogramhasbeencriticizedon

thegroundthattheexistenceofatoiletdoesnotensureitsuse,arecentsurveyby

thegovernmentfoundthatnineoutoftenhouseholdswithaccesstotoiletsare

usingthem.Themissionhasgenuinelycaughtonwithofficialsatthestate,district

andlowerlevelsofadministrationgettingdirectlyinvolvedinbringingabout

behavioralchange.

3.14 Budget-related Reforms

Manyeconomistshadarguedforyearsthatthedistinctionbetweenplanand

non-planexpenditureswasartificialandcounter-productiveandshouldbe

discontinued.Planexpenditureshadcometobeseenasdevelopmental

expendituresandthereforemoredesirableandnon-planexpenditureascurrent

expendituresandthereforelessdesirable.Thistiltedtheexpendituresunduly

towardsplanexpenditures.Thereality,however,wasthatmanyofthelargeplan

expendituressuchassalariesofteacherandhealthworkerswerecurrent

expenditureswhilemanynon-planexpendituressuchasthoseonlawandorderand

judiciaryhadanobviousdevelopmentalangle.Keepingthisinview,thepresent

governmenthasdiscontinuedthedistinctionbetweenplanandnon-plan

expenditures.

Similarly,manycommentatorshadsuggestedforsometimethattherewas

norationaleforaseparatebudgetfortherailways.WhentheBritishstartedthe

19

practice,railwaysaccountedforaveryhighproportionofthegovernment

expendituresbutthiswasnolongerthecase.Thegovernmenthasactedonthis

suggestionaswellandmergedtherailwaybudgetwiththegeneralbudget.

Finally,inthepast,withthebudgetpresentedjustamonthbeforethe

beginningofthenewfinancialyear,allocationsofexpenditurestothestatesusedto

getdelayedandvaluabletimeforimplementationwaslost.Withdelayscascading

overtime,oftenstateswereunabletospendalargeproportionofthefunds

allocatedtotheminthelastquarter.Toalleviatethisproblem,thegovernmenthas

begunthepracticeofpresentingthebudgetamonthearlierthaninthepast.Thisis

expectedtoensurethatthecentralministriesarereadytodisbursefundstothe

statesandotherspendingagenciesonthefirstdayofthenewfiscalyear.

4 CriticismsandResponse

Mostcommentatorsagreethatthegovernmenthassuccessfullyplacedthe

economyonastablemacroeconomicpath.Withthreatsofretrospectivetaxation

andotherarbitrarydecisionsrecedingintothebackground,investorconfidencehas

returned.OneindicatorofincreasedconfidenceisthehealthygrowthinFDI.But

thegovernmentisnotwithoutcritics.Threecriticismsstandout:growthisslower

thantheestimatesbytheCentralStatisticalOffice(CSO);growthhasbeenjobless;

andthecostofdemonetizationhasfarexceededitsbenefit.Thesecriticismsrequire

acloseexaminationandresponse.

4.1 Growth is Slower Than the CSO Estimates

EarlycriticsofthegovernmentarguedthattheofficialCSOestimates

overstateGDPgrowth.Thecritiquehastwocomponents:thenewCSOmethodology

20

forestimatingtheGDP,introducedin2015,hasseriousflaws;andtheestimatesdo

notmatchthegroundreality.

In2015,respondingtocomplaintsofvariousshortcomingsoftheold

methodologyofestimatingtheGDP,theCentralStatisticalOffice(CSO)unveiledits

newmethodology.Thismethodologyrevisedupwardthegrowthratesbasedonthe

oldmethodologyforyears2012-13and2013-14.Italsopeggedtheadvance

estimateofthegrowthratefortheyear2014-15at7.4%.Adebatewaskickedoff

immediatelywithcriticsarguingthatthenewmethodologyoverestimatedgrowth

rates.

Thoughcriticshavebeenhighlyvocalinpointingoutflawscharacterizingthe

newmethodology,nonehasofferedimplementablesolutionsthatwouldovercome

theseflaws.Norhavethecriticsarguedthatthenewmethodologyrepresentsa

regressovertheoldone.Afairsummaryofvariousargumentsisthatthechanges

madebytheCSOmakeimprovementsovertheoldmethodologybuttherestill

remainssubstantialroomforfurtherimprovementinthequalityofdataonwhich

estimatesarebased.

Itisalsothecasethatcriticsprovidenobasisfortheircontentionthatthe

newmethodologyoverestimatestheGDPraterthanunderestimatingit.Indeed,

evenifitcouldbeestablishedthatthemethodologyoverestimatestheGDP,itdoes

notautomaticallyfollowthatitalsooverestimatesthegrowthrateoftheGDP.For

thislatterconclusion,itmustbethecasethattheoverestimationbecomes

proportionatelyprogressivelylargereveryyear.Criticshavecomenowherecloseto

establishingthisproposition.Theinevitableconclusionisthatthecritics’claimthat

21

theCSOGDPestimatesoverstategrowthissolelyrootedinthedissonancetheysee

betweentheseestimatesandtheirownsubjectivegloomierassessmentoftheso-

called“groundreality.”Anyclaimsofoverestimationofthegrowthrateon

methodologicalgroundsremainunsubstantiated.

Butwhatcanwesayabouttheargumentthattheestimatedgrowthratesare

outoftunewiththegroundreality?BeforeIsubjectthisargumenttoacritical

examination,letmedrawattentiontoanimportantrelevantpointthatThe

EconomistmadeayearagowhenreviewingthebookProgressbySwedisheconomic

historianJohanNorberg.TheEconomistwrote,“Peoplearepredisposedtothink

thatthingsareworsethantheyare,andtheyoverestimatethelikelihoodof

calamity.Thisisbecausetheyrelynotondata,butonhoweasyitistorecallan

example.Andbadthingsaremorememorable.”6Anexaminationoftheevidenceon

whichcriticsbasetheirassessmentofthegroundrealityrevealsthatthereismuch

truthinthisproposition.

Criticsdefendtheirgloomierassessmentofgroundrealitybypointingtothe

poorperformanceofoneormoresectorsoftheeconomyandtolowratesof

corporateprofits,corporateinvestmentsandtotalinvestment.Invariably,these

assessmentshavebeensubjectiveandpartialwithnoeffortatacomprehensive

assessmentoftheeconomy.Worseyet,someoftheindicatorsofpoorperformance

thatcriticsofferturnouttobefalsewhenassessedagainsthardstatistics.

True,someofthelegacysectorssuchastextiles,steelandconstruction,

whichsufferfromstressedbalancesheetsonaccountofbadinvestmentsmade

6SeeTheEconomist,3rdSeptember2016,“Betterandbetter,”pp.70-71.

22

duringtheUPAyears,havebeenperformingpoorly.Butthepoorperformanceof

thesesectorshadalreadybeenincorporatedintotheGDPestimatesforthelasttwo

yearsoftheUPA.Whathaschangedistheperformanceofsectorsthatdidnotsuffer

fromstressedbalancesheet.Itisthesuperiorperformanceofsectorssuchastwo

wheelers,automobiles,machinerysector,chemicals,pharmaceuticals,softwareand

otherservicessectorsthathaspulledtheoverallgrowthrateupby1.6percentage

pointsonaverageduringthelastthreefullyears.

Asregardstheclaimsoflowratesofcorporateprofits,corporateinvestment

andthetotalinvestment,systematicdataprovethemfalse.Inarecentarticle,Ihave

documentedthatbothcorporateprofitsandcorporateinvestmentasproportionsof

theGDPhavebeenhigheronaveragein2014-15and2015-16thanduringyearsin

whichtheeconomyhadgrownfasterthan8%onaverage.7Systematicevidencealso

failstosupporttheclaimsbycriticsofacollapseinthetotalinvestment.True,the

totalinvestmentasaproportionoftheGDPhasseenasmalldeclinebutitremains

healthyat30%oftheGDPorhigher.8

ThereleaseofGDPgrowthestimateforthefirstquarterof2017-18(April-

June2017)hadreignitedthedebateongrowthintheIndianmedia.At5.7%,this

growthhappenedtobethelowestquarterlygrowthunderthepresentgovernment.

Moreover,itrepresentedthefifthconsecutivequarterlydecline.Thesefactsledtoa

returnofthecriticstothecenterstageofpolicydebate.Themoreextremeamong

7Datafor2016-17arenotyetavailable.8Fordetails,seePanagariya,Arvind,“Floorhasn’tfallenthrough:Don’tgoby‘feel’,economicdatacallformeasuredratherthanprecipitateaction,”TimesofIndia,September25,2017athttps://blogs.timesofindia.indiatimes.com/toi-edit-page/floor-hasnt-fallen-through-dont-go-by-feel-economic-data-call-for-measured-rather-than-precipitate-action/(accessedon20thOctober2017).

23

themwentontoassertthattheeconomywasina“tailspin”andthatIndiamaybe

headingfora“majordepression.”Thecriticismsassumedspecialsignificance

becauseaformerFinanceMinisteroftheVajpayeegovernmenthadbeenatits

forefront.

Therearegoodreasonstoviewthisroundofcriticismswithskepticismas

well.InJanuary-March2016quarter,GDPgrowthhadtouchedthehighof9.1%.

Withthemedium-termannualaveragegrowthrateat7.5%,oddswereheavilyin

favorofadownturninthequarterlygrowthfromthishighrate.Assuchthefallin

thegrowthrateinthefollowingtwoquartersto7.9%and7.5%washardly

surprising.Themainissueiswhythedeclinecontinuedforanotherthreequarters

insteadofreversingitself.Theexplanationforthisfactliesintwoback-to-back

supply-sideshockstotheeconomy:demonetizationinNovember2016andfirming

upoftheexpectationthattheimplementationoftheGSTwouldbeginon1stJuly

2017.

Demonetizationon8thNovember2016hadrenderedillegal86%ofthe

currencyincirculationintheformof500-and1,000-rupeenotes.Thefactthat

despitesuchalargeshockgrowthratefellfrom7.5%inJuly-September2016

quartertojust7.0%inOctober-December2016quarterand6.1%inJanuary-March

2017quartertestifiestotheresilienceoftheeconomy,notitsweakness.

Undernormalcircumstances,mostlikely,thegrowthratewouldhave

experiencedrecoveryduringApril-June2017quarter.Butthesecondshock—

firmingupoftheexpectationbytheendofMarch2017thattheimplementationof

theGSTwasimminent—preventedthisrecovery.RecognizingthatnoGSTrebate

24

willbeforthcomingonindirecttaxespaidontheinventoryaccumulatedpriorto1st

July2017,retailers,wholesalersandmanufacturerstemporarilystoppedorslowed

downinventoryaccumulation.Theresultwasasharpreductioninmanufacturing

growth,whichlargelyaccountedforthefallintheoverallgrowthto5.7%duringthe

quarter.

TheCSOhasnowreleasedtheGDPgrowthestimateforJuly-September2017

quarterplacingitat6.3%.Thedeclineinthegrowthratehasthusbeenreversed

andgoingbythecommentarybyanalystsatvariousbanksandotherinstitutions,

thistrendisexpectedtocontinue.Nearlyallforecastersplacethegrowthratefor

fullfiscalyear2017-18at6.5%orthereaboutsandfor2018-19wellabove7%.

4.2 Growth has been Jobless

Thesecondmajorcriticismofthegovernmentpolicieshasbeenthatthey

haveproducedjoblessgrowth.Inofferingthiscriticism,criticshavereliedontwo

mainsourcesofinformation:mediareportsofworkerlayoffsandemployment

creationestimatesfromaquarterlyenterprisesurveyconductedbytheLabor

BureauoftheMinistryofLaborandEmployment.Bothsourcesofinformation

sufferfromseriousproblems.

Fewinformedanalystswoulddisagreethatanyconclusionregardingjob

creationonthebasisofmediareportsispatentlyunscientific.Indeed,sincebad

newssellsalotbetterthangoodnews,itisjoblossesthatgetdisproportionately

greaterplayinthemedia.Ifoneweretosystematicallyanalyzemediareports,oneis

likelytofindthatineveryyear,joblosseshaveoutnumberedjobadditions.Correct

25

evaluationrequiresscientificsurveysthattakeintoaccountalljobcreationandall

joblosses.Anyclaimsbasedsolelyonnewsreportsmustberejected.

Asregardsenterprisesurvey,inIndia,ittoosuffersfromseriousproblems.

ThisisbecauseaverylargeproportionofthelaborforceinIndiaiseitherself-

employedoremployedinverysmallenterprisesthattypicallydonotformapartof

theenterprisesurveys.Therefore,ifself-employedworkersfindajobinalarger

enterprisecoveredbytheenterprisesurvey,nochangeinthetotalemployment

wouldhavetakenplaceandyetthesurveywouldreportincreasednumberofjobs.

Symmetrically,ifaworkerislaidofffromalargeenterpriseandfindsemployment

inasmallenterprisethatisnotcoveredbytheenterprisesurvey,wewould

concludethatthenumberofjobshasfallendespitenonetchangeinthisnumber.

TheLaborBureauenterprisesurveyonwhichmanycriticsrelysuffersfrom

thisandotherflaws.Itisconfinedtoenterpriseswith10ormoreworkersina

selectedsetofsectors.InIndia,theseenterprisesaccountforaverysmall

proportionofemployment.Evenwhenweincludeallsectors,accordingtotheSixth

EconomicCensus,conductedin2013-14,enterpriseswith10ormoreworkers

accountforonlyone-fifthofnon-agriculturalworkers.Byexcludingtheself-

employedandemployeesofenterpriseswithlessthantenworkerseach,thesurvey

failstocoverfour-fifthofnon-agriculturallaborforce.Thisexclusionmeansthat

nothingfromthesurveyallowsustosayanythingaboutthetotalemployment.

Thesurveyhasotherproblems.UntilDecember2015,theselectionoffirst-

stageunitsinthissurveywaspurposiveratherthanrandom.Asaresult,any

inferencesfromsampleunitsforthepopulationarerenderedstatisticallyinvalid.

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Surveyreportshavenotedthisflawbutcriticshavepaidnoheedtoit.Furthermore,

thecoverageofsectorsandstatesinthesurveyhaschangedovertime.Thisis

particularlytruebetweensurveysconductedbeforeandafter2015.Hadthe

selectionbeendoneonarandombasis,thiswouldnotmatter.Butthisnotbeingthe

case,comparisonsofestimatesovertimearewhollyinvalid.

Claimsofjoblessgrowthbycriticsthuslackvalidempiricalfoundations.In

aneconomyinwhichdisproportionatelylargenumberofworkersareself-

employedoremployedinverysmallenterprises,onlylarge-scalehousehold

surveys,whichextendtotheentirepopulation,canofferreliableestimatesof

employmentandunemployment.Indiahasconductedthesesurveyseveryfive

yearssince1972-73andtheydonotsupportthehypothesisofjoblessgrowth.

Basedonusualprincipalstatusoftheworker,thesesurveysconsistentlyplace

unemploymentrateatorbelow5%withlimitedvariationovertime.Forinstance,

theunemploymentratewas4.9%in2013-14and5%in2015-16.9

Simpleeconomiclogicsupportsthehypothesisthatrapidgrowthincluding

thatunderthepresentgovernmentcouldnothavebeenjobless.Asapurely

accountingmatter,growthintheGDPistheresultofgrowthininputsand

productivity.Studiesoverwhelminglyshowthatinthebestoftimes,productivity

growthdoesnotcontributemorethan3-percantagepointstoGDPgrowth.

Therefore,asubstantialproportionofthe7.5%GDPgrowthexperiencedduringthe9ThemostcompleteandcomprehensiveestimatesofemploymentandunemploymentinIndiacomefromhousehold-basedlarge-scaleEmployment-UnemploymentSurvey(EUS),whichtheNationalSampleSurveyOffice(NSSO)hasconductedapproximatelyeveryfiveyearssince1972-73.TheEUSusesthepopulationcensusasthesampleframeandthereforecoverstheentirepopulation.AlthoughthelastNSSOEUSwasconductedin2011-12,theLaborBureauhasbeenconductingasimilarlarge-scalehouseholdsurveywithsomemodificationstothesurveydesignapproximatelyannuallysince2010.

27

lastthreeyearshastohavebeencontributedbygrowthincapitalandlabor.

Recognizingthatgrowthincapitalhasseenaslightdecelerationduringthepast

threeyears,asamatterofpurearithmetic,laborinputgrowthcouldnothavebeen

anyslowerthanduringtheearlieryearsofrapidgrowth.

Criticismsofjoblessgrowtharethusseentobewithoutsoundempiricalor

logicalfoundation.Butitdeservesnotingthatthoughtheunemploymentratein

Indiaislow,thecountrydoessufferfromaseriouslong-termunderemployment

problem.Giventhelimitedavailabilityofsocialsafetynets,nearlyalladultsinIndia

mustengageinsomeeconomicactivitytosurvive.Butthereisnotenough

economicactivitytogenuinelyemploymostworkersfull-timeatwhatis

conventionallyconsideredthenormallevelofeffort.Therefore,oftentwoormore

workersarefoundperformingtasksthatoneworkerworkingfulltimeatthe

normallevelofeffortcouldperform.Asanexample,ifaplumbingjobistobedone,

frequently,twoormoreworkerswouldshowup.Andasoneoftheworkers

performsthejob,theotherssimplywatchhimdoit.

Toputthematterdifferently,alongstandingproblemafflictingIndiasince

beforeIndependencehasbeenthelackofrapidgrowthinhigh-productivity,high-

wagejobsforlow-skilledorunskilledworkers.Innearlyallcountriesthathave

achievedrapidtransformationinthepost-Second-World-Warera,suchas

Singapore,Taiwan,SouthKoreaandChina,thesejobshavebeencreatedbyexport-

orientedlabor-intensiveindustriessuchasapparel,footwear,furnitureandother

lightmanufactures.Withtheseindustrieshighlyfragmented,fartoomanyworkers

inIndiaremainself-employedoremployedintinyenterpriseswheretheirlaboris

28

grosslyunderutilized.Growthinthecountryhasbeendrivenbycapital-andskilled-

labor-intensivesectorssuchasauto,autoparts,twowheelers,machinery,

petroleumrefining,telecommunications,pharmaceuticals,informationtechnology

andfinance,whichcreatefewjobsfortheunskilledorlowskilled.Consequently,

underemploymentofadisproportionatelylargepartoftheworkforceinheritedat

Independencecontinues.Thisisakeyweaknessneedingurgentredress.

4.3 Demonetization

Ihavealludedearliertodemonetizationasoneoftheseveralmeasuresthat

thegovernmenttooktocombatcorruption.On8thNovember2016,thegovernment

discontinuedlegaltenderstatusoftwolargest-denominationcurrencynotes,Rs.

500andRs.1,000,whichaccountedfor86%ofthetotalcurrencyincirculationat

thetime.Thoseholdingthecurrencynoteswereaskedtobringthemtobanksby

certaindatewithbanksauthorizedtoconvertsmallsumsintonewcurrencynotes

andtaketherestasdepositswithproperrecordsofthetransactionsmaintained.

Thelogicbehindthemeasurewasthatthoseholdingunaccountedwealthinthese

large-denominationcurrencynoteswillnotbeinapositiontoexplainthesourceof

theirwealthandthereforewouldchoosenotbringtheircurrencyholdingstobanks.

Inthisway,unaccountedwealthheldinlarge-denominationcurrencynoteswould

beexpunged.

Intheevent,nearlyallcurrencyreturnedtothebankingsystem.Thereare

reportsthatthosewithunaccountedwealthinthediscontinuedcurrencynotes

foundavarietyofavenuestolegallychannelingthemintothebankingsystembut

thisremainstobeverified.Forinitialseveralweeks,demonetizationproducedlong

29

queuesatthebanks.Becauseittookthreemonthstoadequatelyremonetizethe

economy,therewassomedislocationofeconomicactivity.

Commentatorshaveofferedthreemaincriticismsofdemonetization:(i)It

ledtosubstantialinconveniencetopeoplewhohadtostandinqueuesatbanksfor

longhoursforseveralweeks;(ii)Economicactivitywasdislocatedleadingtoa

declineinthegrowthrate;and(iii)Becausenearlyalldiscontinuedcurrencynotes

returnedtothebankingsystem,theobjectiveofcombatingblackmoneywasnot

fulfilled.

Inevaluatingthesecriticisms,letmebeginbynotingthatthegovernment

hadsurelyanticipatedthatdemonetizationwouldproducelongqueuesforsome

weeks.Ittookthatriskinthebeliefthatpublicatlargewassupportiveofthe

government’sresolvetocombatcorruption.Thatbeliefturnedouttobetrue.Ina

countrywherequeuesformovieticketsorforcollectingsubsidizedfoodgrainat

governmentshopscanleadtoargumentsandsquabbles,thelongqueuesforweeks

togethertriggeredhardlyanysuchincidents.Thecommonmanstronglywelcomed

thefactthataleaderhadfinallycomealongwhowaswillingtofrontallyattack

corruptionandthecorrupt.Theelite,whoseeaninsultinhavingtostandinany

queue,mayhavebeenappalledbythosequeuesbutthecommonmanwashappy

thatthistimearoundtherichtoohadtostandalongsidethemtodeposittheir

moneyandexchangeoldcurrencyfornew.Thedecisivevictoryofthepartyofthe

primeMinisterintheUttarPradeshelections,whichfollowedsoonafter,strongly

suggeststhatpeoplewelcomedhisassaultoncorruption.

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Inasimilarvein,thegovernmentalsounderstoodthatsometemporary

dislocationofeconomicactivitywouldtakeplaceinresponsetothewithdrawalof

86%ofthecashfromtheeconomy.Whatisremarkable,however,ishowlimited

thisdislocationturnedouttobe.Duringtwofullquartersimmediatelypriorto

demonetization,growthhadsuccessivelydeclinedto7.9%and7.5%from9.1%.

Duringthequarterinwhichdemonetizationtookplaceandtheonethatfollowedit,

growthratefellto7%and6.1%,respectively.Thesedeclineswerefarbelowwhat

nearlyallcriticshadpredictedimmediatelyfollowingtheannouncementof8th

November2017.

Thefirsttwocriticismsmentionedaboveare,thus,greatlyoverstated.The

cruxofthematter,therefore,iswhetherdemonetizationachievedmuchsuccessin

movingthefightagainstcorruptionforward.Herecriticshaveseizedonthefactof

thebulkofthecurrencyhavingreturnedtothebankingsystemasdecisiveevidence

thatnoprogressinthisregardwasmade.

Butthisisanonsequitursincethelackofreturnofunaccountedcashtothe

bankingsystemwasonlyoneamongmanyavenuesthroughwhichdemonetization

couldhavehelpedcurbblackmoney.Whilethisavenuedidfailtopenout,atleast

threeotheravenuesopenedbydemonetizationhavesuccessfullycontributedtothe

fightagainstunaccountedwealth.

First,thoughnearlyallmoneyhasreturnedtothebankingsystem,ithas

returnedwiththenameoftheownerattachedtoit.Thelattermustnowexplainthe

sourceofhisorhermoney.Thosewhohaveengagedinsuspiciousactivitiestohide

thesourcearenowunderinvestigationandfacetheprospectsofprosecution.

31

Already,theMinistryofCorporateAffairshasidentifiedandde-registered224,000

companiesanddisqualified310,000individualsforfuturedirectorshipof

companiesasaresultoftheinvestigationstriggeredbydemonetization.The

IncomeTaxDepartmentisundertakingsimilarinvestigations.Asapartofits

“OperationCleanMoney,”ithasidentified100,000“highrisk”casesoftaxevasion

andpicked20,572taxreturnsfordetailedscrutiny.

Second,avastvolumeofunaccountedmoneyisheldinrealestate.Inone

stroke,demonetizationcuttherealestatepricesbyaquarter.Thisamountstothe

destructionof25%oftheblackwealthheldinrealestate.10Thepricedeclineand

demonetizationalsomakefutureaccumulationofunaccountedwealthinrealestate

lessattractive.

Finally,demonetizationandinvestigationslaunchedinitsaftermathhave

sentastrongsignalthatthepresentgovernmentisfullycommittedtocombating

corruptionandwillnothesitatetotaketoughactions.Thisfactbyitselfpromisesto

actasadeterrenttofuturecorruption.Withtheeffectivecostofaccumulationof

blackmoneythushavinggoneup,onthemargin,wemustseeadeclineinsuch

accumulationinthefuture.

Whilecontributingtothecentralobjectiveofcombatingcorruptioninthis

manner,demonetizationhasproducedseveraladditionalpositivesideeffects.The

currencyincirculationhascomedownby12to13%ofitslevelon8thNovember

2017andthecurrency-to-GDPrationowstandsatalevelsimilartothosein

10Somecriticsrespondthatthishasbeenharshonhonesthouseownerswhohavealsoseenthevalueoftheirhousesdeclineby25%.Thisisafalseargumentsincetheoriginalincreaseinthehousingpricesitselfwastheresultoflargeinvestmentsofunaccountedwealthintherealestate.

32

comparablecountries.Theamountofdirecttaxrevenuecollectedandthenumber

ofincome-taxpayershaveseenasignificantrise.Therehasbeenastepincreasein

digitalpayments.StonepeltinginKashmirandleft-wingextremismineasternstates

havewitnessedasharpdeclineduetotheblowdemonetizationadministeredto

financingoftheseactivities.

5 ConcludingRemarks

Inthisarticle,Ihaveprovidedthefirstcomprehensiveevaluationofthe

economyduringthefirstthreeandahalfyearsoftheModigovernment.Thearticle

beginsbysummarizingtheeconomicconditionsunderwhichthegovernmentcame

tooffice.Itarguesthathavinginheritedaneconomywithlowgrowth,highinflation

andlargefiscaldeficit,thegovernmenthassuccessfullystabilizedit.Duringthefirst

threeyearsofthegovernment,theeconomygrew7.5%onaveragecomparedwith

5.9%duringthelasttwoyearsofthepredecessorUPAgovernment.

Thearticlegoesontosummarizethekeyprocessandpolicyreforms

introducedbytheModigovernment.Thisdiscussionshowsthatwithinthreeanda

halfyears,thegovernmenthasbeenabletoconsiderablywidenanddeepen

reforms.Whilesomeofthesereformshaveyieldedimmediateresults,theeffectof

manystructuralreformssuchastheInsolvencyandBankruptcyActandtheGoods

andServicesTaxwillbegenuinelyrealizedoverthelongertimehorizonofthreeto

fiveyears.Thearticlealsosubjectstocriticalexaminationtheargumentsbycritics

inthreeareas:overestimationofgrowthrates,jobcreationanddemonetization.

Tolimitthepapertoareasonablelength,Ihavenotdiscussedtheprogress

madeininfrastructure,energy,agriculture,innovation,entrepreneurship,skill

33

developmentandsocialsectors.NorhaveIdiscussedthereformsthatthe

governmentmustundertakeduringitsremainingtermandsubsequentlyshouldit

returntopowerfollowingthe2019parliamentaryelections.11InthefollowingI

brieflytouchonsomeofthesereforms.

Firstandforemost,thegovernmentmustadvanceandhopefullycomplete

someofthereformsalreadyinthepipeline.Theseincludeprivatizationofpublic

sectorenterprisesthatdonotserveanypublicpurposeincludingAirIndia;cleanup

ofthenon-performingassets(NPAs)andrecapitalizationofpublicsectorbanks;

passageoftheNationalMedicalCommissionBill,whichaimtobreathnewlifeinto

medicaleducationbothquantitativelyandqualitatively;passageoftherelatedbills

onhomeopathyandIndianmedicalsystemseducation;andfinancialandacademic

autonomytobetter-performinguniversitiesandcolleges.

OncethegovernmentacquiresmajorityintheUpperHouseofthe

Parliament,itmustalsogetdowntothebusinessofwholesalereformoflaborlaws.

Thisisnecessaryevenifnotsufficienttocreateanemployment-friendlyregimein

thecountry.Alsoimportantistorevisitthereformoftheperniciousland

acquisitionactthatthegovernmentinheritedfromtheUPA.OnceNPAshavebeen

dealtwithandbanksrecapitalized,thegovernmentmustconsolidatepublicsector

bankintofiveorsixandgraduallyprivatizethem.Aroadmapofhowpreciselythe

twotasksshouldbeaccomplishedmustbedrawn.Manyofthefuturereformswill

havetobedoneatthelevelofthestatesandcitiesandthiswouldrequirecontinued

11TherecentlybroughtoutThreeYearActionAgenda:2017-18to2019-20providesacomprehensivediscussionofthedesirablereformsinnearlyallareasofpolicy.Theinterestedreadermustconsultthisdocument.Itmaybedownloadedfromhttp://niti.gov.in/content/three-year-action-agenda-2017-18-2019-20.

34

cooperationbetweenthecentralgovernmentandstatesandbetweenstatesand

cities.UrbanizationisgoingtobeIndia’sbiggestchallengeintheyearstocomeand

bothcentralandstategovernmentsmustcooperatetomeetit.