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Mainstream, VOL LVII No 1 New Delhi December 22, 2018 [Annual Number]

Challenges of Dichotomous Growth in India

Sunday 23 December 2018


by Arun Kumar

The election results from the three North and Central Indian States suggest that farmers, youth and small businessmen are unhappy. Some of them have been openly agitating. Why is this happening if the rate of growth of the economy is between seven and eight per cent, as the official figures suggest? Businessmen have agitated less because they fear an authoritarian government. The minorities and Dalits are upset for economic and social reasons. These marginalised groups are also the poorest and suffer the most when the economy does poorly. The resignation by the RBI Governor is another indication that all is not well with the economy and its institutions.

It is claimed that India is the fastest growing economy in the world. But if that was so, some of the social and political dissonances being witnessed in the country would have got moderated. Many say that the ‘feel good’, like during the high growth phase of 2005-2007, is missing. So, how well is the economy really doing?

Impact of the Two Big Shocks to the Economy

No one denies that India has been administered two big shocks in quick succession in the last two years—demonetisation and the GST. Even official spokespersons now admit that these two slowed down the economy. But they say that the impact of the shocks was marginal and also claim that the economy has now recovered and is on a new higher growth path. It is also claimed that due to the push for digitisation, the economy is getting formalised and that will boost economic performance. The government bolsters its argument by quoting agencies like the IMF and ADB which seem to endorse the government’s view.

The international agencies endorse the government’s view because they do not have independent data. Their data is the government data. They can only interpret it and come to slightly different conclusion but that cannot be out of line with what the government says. There is also consultation between the international agencies and the Ministry of Finance and the latter is able to influence them. In brief, the endorsements by the international agencies is not an independent judgment.

So, what was the impact of the two shocks and has it abated? As this author has been repeatedly arguing in the last two years, the two shocks impacted the unorganised sectors of the economy the most. The organised sectors were also impacted but much less.

The cash shortage created by demonetisation lasted for at least a year and since the unorga-nised sector works largely with cash and uses little of banking and electronic means of transactions, its functioning came to a grinding halt. There were reports of large scale closures of the units in this sector and of the workers going back to the villages in search of jobs. Since these units work with small amounts of working capital, if they stop production, the owners of these units cannot generate incomes and are forced to use their working capital for daily consumption. It gets exhausted quickly and they are forced to go into debt. To revive their units they have to borrow at high interest rates from the informal markets. The reports are that many units have not yet opened and many workers have not returned from the rural areas and that is why the demand for work under the MGNREGS remains high for the last two years.

The organised sector has taken advantage of the decline in the unorganised sector by expanding its output. So, its expansion is at the expense of the unorganised sector. This is an ongoing trend in the economy. For instance, in retail trade the expansion of the organised sector (like, Reliance Fresh or Big Bazar) was already reducing the market for the local retail stores in the unorganised sector. This trend has been aggravated by the emergence of e-commerce in the last few years—the growth of Flipkart and Amazon has further reduced demand in the unorganised sector.

Another factor at play is that the demand in the unorganised sector comes largely from its own incomes and less so from the organised sectors. As the incomes in the unorganised sector have declined, so has the demand for its own products. This has prevented the unor-ganised sector’s revival.

Take, for example, the impact on the agriculture sector which is reeling under a crisis. Farmers face low demand for their product and so they get a low price for their produce. This has affected their incomes. Farm surpluses are a result of low demand and not excess production. After all there is a lot of malnourish-ment among a large section of the population. Further, modern agriculture is high cost which leads to lower incomes. No wonder many farmers are unable to repay their loans and face a crisis. That is why the demand for loan waiver has arisen all across the country. The government has not published data on farmers’ suicides in the last two years.

The notes in circulation are now more than they were in October 2016, so that the shortage of notes due to demonetisation can be said to be over but its impact lingers on with the unorganised sector not reviving and a dicho-tomous growth taking place.

The Goods and Services Tax (GST) was imple-mented within nine months of the announce-ment of demonetisation and before the economy had recovered from demonetisation. It is so complicated that it impacted both the organised and unorganised sectors of the economy. But again the unorganised sector was affected more even though it was largely exempted from the GST.

There is a design flaw in the GST. If the small units register under the GST, they face increase in costs which undermines their meagre profits. If they do not register under the GST, they do not get input credit; so their costs rise compared to the organised sector. Further, they cannot give input credit to their buyers so that the cost to their purchasers rises and they prefer to buy from the organised sector. Finally, if someone from the organised sector buys from those units that are not registered, a reverse charge has to be paid and the cost rises further. So, the unorganised sector units have to drop prices in spite of increase in costs and that squeezes their incomes. Due to these three factors, the demand has shifted from the unorganised sector to the organised sector making the former increasingly unviable.

The organised sectors have also faced problems since the GST is very complicated. Hundreds of changes have been announced since the inception of the GST in July 2017 adding to the confusion. As the GST was designed, it requires registration in each State in which the company operates. Further, for each State, three forms have to be filled every month. And there is an annual form for each State. Thus, there are 37 forms to be filled for each State. For a company operating all over India, like a consumer company, there are more than a thousand forms to be filled every year.

Add to that the complications related to the e-way bill, required to transport goods even within a city. It was supposed to ease trans-portation by eliminating toll tax and entry tax barriers, create seamless movement and unify India into one market. However, there is no getting away from inspection of the trucks since misclassification of goods is rampant. This has led to large scale corruption and delays. Further, stoppage continues at the toll plazas.

The GST was supposed to lead to elimination of the cascading effect of taxes but with the multiple rates announced (0,5,12,18,28 per cent and 15 per cent cess on some items) that has not happened, even though it is less than earlier. Further, keeping important goods like petroleum products and electricity out of the GST has resulted in the continuation of an important cascading component. Multiple tax rates have led to misclassification and black income generation. The small businesses registered under the ‘Composition Scheme’ have a one per cent rate of tax; so that is another rate. Gold and gems and jewellery are under yet another slab. So, the multiplicity of rates is high.

Reports suggest that businesses have not passed on the benefit of input credit to the consumers and increased their own profit margins. This was the case with restaurants and when this author pointed it out in an article, input credit was withdrawn from restaurants and they were brought under a flat five per cent tax. There are persistent reports of businesses making greater profits and that has proved to be inflationary.

The GST has also proved to be inflationary since to collect more tax, many goods and services were placed in tax slabs higher than earlier. For instance, most services were under a 15 per cent tax rate but under the GST they were placed in the 18 per cent slab. Thus, prices of most services rose leading to higher inflation. This is not reflected in the inflation numbers since many services are not counted in the inflation indices. So, the official data claims that the inflation numbers are low while the public feels the pinch of rising prices.

The government expected that the GST will lead to higher tax collection and a check in the black economy. But till now, collections under the GST have been much less than expected resulting in a rising pressure on the government’s finances. Fiscal deficit in 2018-19 is turning out to be higher than what was slated. To keep this in check, cuts in expenditures have been made like in education. Libraries of many universities have faced big cuts in their budgets. Even research grants have been curtailed. The long- term health of these institutions is being jeopardised.

Many schemes announced with much fanfare are languishing due to inadequacy of funds. For instance, the Ujjwala scheme to provide gas cylinders to the poor or the ‘Swacch Bharat’ schemes have not been able to deliver as they ought to have.

In brief, the claim that the GST will be a win-win for all has not materialised. The growth rate has fallen, prices have risen and tax collection has been less. Federalism has been dented which will have a long-term effect and raise inequalities. Inequalities will also rise due to the differential impact on the organised and unorganised sectors.

Fudging to Show Higher Growth Rate

Official data shows that the economy’s growth has recovered to between seven and eight per cent. This may be true for the organised sector but is certainly not true for the unorganised sector which produces 45 per cent of the output and employs 93 per cent of the workforce.

The data for the unorganised sectors is collected once every five years in what is called the ‘reference’ year. In that year, productivity of labour is worked out and used till the next survey is carried out. In the case of quarterly growth rates, the projection is based on the data from the organised sectors. In effect, the organised sector is taken as the proxy for the unorganised sector.

This methodology is fine when there is no shock to the economy. If a shock has differential impact on the organised and unorganised sectors of the economy, then this methodology does not give the correct results. As discussed above, that is what happened due to the GST and demonetisation. So, the methodology that was applicable on November 7, 2016 is not applicable on November 9, 2016, after demoneti-sation. New ratios need to be worked out. The same is true for the scenario after July 1, 2017 when the GST was implemented.

All private and semi-private surveys carried out during demonetisation showed that the unorganised sector was severely impacted. Even the RBI report in March 2017 showed that the consumer durables sector declined sharply. The decline in credit off-take from banks and rise in demand for work under the MGNREGS supported the argument of a sharp decline in the economy. The various surveys showed a drop in output of upto 50 per cent.

Even if one assumes that the organised sector did not decline and continued to grow at the officially announced rate of growth of six to seven per cent and the unorganised sector only declined by 10 per cent, the rate of growth of the economy would turn out to be less than one per cent—not the six to seven per cent rate of growth announced officially.

In brief, the two shocks have led to a sharp drop in the rate of growth in the economy over the last two years. This is policy-induced and not due to external factors as was the case in 2007-08 and 2012-13.

This brings one to the recent controversy about whether or not the average rate of growth during the present NDA regime is higher than that during the UPA period. This is important politically since the present regime has constantly argued that all progress has been made during the last four years and little happened in the earlier Congress regimes over the last 70 years. If the rate of growth turns out to be higher during the UPA regime, then the NDA’s argument is falsified.

The GDP data is periodically adjusted for various changes taking place in the economy. This is referred to as the change in the base. During the UPA regime the exercise was started to change the base year from 2004-05 to 2011-12. The new data was announced in January 2015 when the NDA was in power. The change led to an upward revision in rates of growth during the last two years of the UPA regime and also in the first year of the NDA regime. This was a result of using the larger data base provided by the Ministry of Corporate Affairs in its data base called MCA21. But this new data base was not available for the earlier years in a comparable form. So, the problem arose as to how to make the earlier data comparable to the post-2011-12 data.

The data series for the earlier years on the basis of the new base year is called the ‘back series’. The MCA series was available only after 2007-08 but its coverage kept changing till 2011-12; so, it was not comparable and could not be used to create a back series. A sub-committee of the National Statistical Commission prepared a back series based on an established methodology called the ‘production shifting approach’. It has its own problems but so do other methods.

The back series prepared by this sub-comm-ittee showed that the performance during the UPA regime was slightly better than during the NDA regime and in two years the rate of growth of the economy was above 10 per cent. A political storm broke out and the NDA rejected this back series. It was argued by the Minister of Finance that the higher growth was due to the UPA’s profligacy which led to problems for the NDA. However, indirectly it was also an admission that the rate of growth was indeed higher during the UPA regime.

The rejection of this back series by the NDA suggested that a new back series would be produced with a different result. That is what has been done by the official agency, the CSO. Its back series shows that the rate of growth during the NDA regime is better than during the UPA period. The methodology is justified on the ground that it is based on the UN recommended System of National Accounts (SNA) 2008.

But, it has now come to light that three years back when this same agency had produced a back series showing a higher growth rate during the UPA regime, the then Vice-Chairperson of the Niti Ayog prevented that data from being released. The political intent becomes clear.

The controversy on the GDP back series shows that a) the Niti Ayog is acting as a political wing of the government and not a neutral agency, b) the GDP series are now a political tool of manipulation. However, data has always been manipulated by governments to show themselves in better light, but now it is being done more blatantly. This credibility of the Indian official data, the Niti Ayog and its Vice-Chairperson is being dented.

Institutions in Decline

This fits in with the pattern of attack on institu-tions during the last four years. Educational institutions, Courts, Niti Ayog, police forces, RBI, banks and so on have been attacked and sought to be brought under the control of the ruling regime.

The RBI Governor’s resignation with immediate effect implies that the pressure on him from the government had increased to a point that he could not continue. While the discord had been building up between the two, it seemed that the differences had been settled in the previous meeting in November. Obviously that was not the case—perhaps the government pushed too hard to have its way. The reaction of the PM and FM to the resignation suggests that the government welcomes the resignation with immediate effect so that it can place its own person and have its way. It needs the RBI’s reserves before the national elections to provide for additional popular expenditures to win additional votes.

Demonetisation brought down the credibility of the RBI, banks and money. It damaged Parliament since it did not debate the most important economic event in the last decade. It damaged the functioning of the Cabinet system since the Cabinet was not consulted even though it affected major Ministries—Finance, Commerce, Agriculture and so on.

The four SC judges holding a press conference for the first time in independent India was unprecedented and showed the depth of the crisis there. The recent problems in the CBI indicate the extent of damage to this institution due to increasing political interference. To be fair the SC had termed the CBI as a ‘caged parrot’ much earlier but the events now unfolding are unprecedented. Those at the top are all accused of corruption.

Interference in institutions of higher education has been unprecedented. The government has been in a tearing hurry to capture institutions or damage them. Poor calibre supporters of this regime have been made the heads of these institutions. In turn, they have manipulated selection committees to appoint poorly qualified faculty thus damaging the institutions over the long term. Decision-making bodies of univer-sities—the Academic and Executive Councils— have been packed with yes men, eroding the autonomy of universities.

The functioning of the Ministry of Human Resources, University Grants Commission, Indian Council of Social Science Research and other such bodies has been damaged. They have collectively undermined the autonomy of institutions of higher learning. All this will have long-term impact on the democratic ethos of the country.

The GST has impacted the basic federal structure of the country. It falls foul of the ‘basic structure’ doctrine propounded by the Keshavanand Bharati judgment. India is a very diverse country with different parts of the country at different levels of development. Thus, the needs of Assam are different from those of Maharashtra, etc. So, the same policy of taxation and expenditure will not work for both. That is why the Indian Constitution provided for autonomy. The GST has undermined that by prescribing the same tax rate for all States. It also damages the poorer States because the unorganised sectors are concentrated in the poorer States. Thus, even though the GST is supposed to be a last point tax, it will aggravate inter-State inequity in the country.

In brief, various democratic institutions are being damaged, especially in the last two years. This will have long-term adverse consequences for the country.

Fiscal Situation and Black Economy

In the first seven months of this fiscal year, the fiscal deficit has crossed the budgetary target. It is likely to exceed the annual target, especially given that the national election is coming and the government may announce schemes to attract the voters. While this is not bad for an economy that has a lot of spare capacity, the world of finance frowns on such slippage. It may downgrade the economy and that could raise the cost of borrowing for Indian businesses.

The problem emanates from the slippage in the collection of revenue from the GST. The government was also hoping to collect more from direct taxes, especially as it claims that demonetisation has brought into the tax net a lot of new taxpayers. The GST and digitisation were also supposed to add to these numbers.

Indeed, the government claims that the number of taxpayers has increased by a pheno-menal 50 per cent. However, direct tax collections have only risen by 16 per cent according to the data released by the CBDT. This is nothing unusual. Earlier also when many obtained PAN cards and were registered as taxpayers, the amount of tax collection did not rise proportio-nately. The reason is that a large number of the new registrants have low incomes but they are required to register.

The government has constantly announced that after demonetisation, it issued 18 lakh notices to those who deposited more than Rs 5 lakhs into their accounts. But depositing large sums of cash does not necessarily make it black. Businesses with large turnovers like petrol pumps, telecom companies, jewellers, real estate firms, hospitals, shopkeepers and so on have a lot of daily cash transactions. In 50 days they would have deposited crores of cash into their bank accounts. All this is not black even if some of it maybe black. The Income Tax Department will have to audit them and prove that they deposited black cash. Not only is it not easy, the Income Tax Department does not have the manpower to audit so many accounts quickly.

In the last two years since demonetisation, very few have been caught under the relevant provisions. It can take years to prove that the balance-sheet was manipulated by the businesses. Even if prosecution takes place, businesses appeal against the decision and in such cases mostly the government loses. Further, there are persistent reports that in the case of the GST and direct taxes, the department is asking businesses to pay tax and then claim refund afterwards. But refund is being delayed so as to show higher tax collections.

The number of income tax payees has risen due to the increase in salaries consequent to the Seventh Pay Commission. So, many new low income tax return filers have been created who either pay little tax or have no taxable income. Similarly under the GST about 1.1 crore registrations have taken place but the number of those paying the GST is only about 65 lakhs. The Finance Minister himself famously said that five per cent of the taxpayee pay 95 per cent of the tax. No wonder it is not the number of tax-filers that is important but how much tax do they pay.

The government argues that things would improve over time, especially due to digitisation and formalisation. Black income generation would decline and tax collection would rise. But, it is the formal sector that generates a bulk of the black incomes and not the informal sector where most of the incomes are below the taxable limit. Some businesses in the informal sector do earn substantial incomes like dhabawallas, traders and so on, but their numbers are small compared to the vast number of people employed in this sector. So, how can formalisation help when it is the formal sector that generates most of the black income? Many from this sector who do get registered would hardly pay any tax. Even the bigger ones who may come into the tax net, would use the mechanisms available in the formal sector for generating black incomes.

In brief, neither demonetisation, nor the GST has been able to make a dent on the generation of black incomes. If that had indeed happened, the direct tax to GDP ratio should have risen sharply. But it has hardly increased by 0.2 per cent. Finally, digitisation or formalisation would also hardly help raise revenue since the informal sector does not generate much black income.

Lagging Employment Generation

If the economy is growing at less than one per cent, that has serious implications for employ-ment generation. The growth has to be disaggregated—between the organised and the unorganised sectors.

The unorganised sectors are the main employers in the economy, providing 93 per cent of the employment. They are the ones that have contracted due to the twin shocks leading to considerable loss of employment. Unfortu-nately, this is not counted. Since there is no social security in this sector, those losing employment in this sector cannot afford to not work and have to take up some residual work. So, they get counted as employed. Further, they seek work under the MGNREGS and again get counted as employed. The point is that they lose their preferred work and are forced to do residual work at low wages.

The organised sector generates few jobs since it is mechanised and is getting automated. Thus, it generates few jobs. This is jobless growth. Further, to the extent this sector is growing at the expense of the unorganised sector, it displaces jobs. For instance, taxi aggregators providing jobs is at the expense of the taxi stands in cities and the drivers in households and companies. Very few new jobs are created—there is a redistribution from one kind to the other. Similarly, in the retail sector as e-commerce grows and displaces the neighbourhood stores, employment drops. Thus, in the net, there is displacement of employment rather than an addition.

Lack of alternative employment is the reason that workers and farmers who would like to leave farming are unable to do so. They are stuck there. No wonder there is discontent in rural India. Farmers have inadequate incomes but are unable to give up their vocation.

Impact of External Sector Instability

The internal instability is reinforced by the external instability facing the Indian economy. Since 1991 the Indian economy has become a much more open economy so that the impact of external developments is immediately felt by the Indian economy. If the stock markets in the US and Europe fall, so does the Indian stock market. If petroleum prices rise, energy prices in India also rise leading to higher levels of inflation. Capital movements globally also impact the Indian financial markets. This has led to narrowing of policy-options for the Indian Government and also weakened labour while strengthening capital.

A major source of instability comes from the US. Mr Trump, the US President, has imposed sanctions against Iran, raised tariffs against Chinese goods and so on. These actions are destabilising the world economy and politics. He has also acted against India, the European Union and changed the NAFTA agreement. He is demanding that more jobs be created in the US and for that reason raised tariffs. This is impacting the WTO. India could have gained from these actions of Mr Trump if it was not so open but in the present situation of a much more open economy all these steps are having a negative impact on the economy.

The US action against Iran is destabilising West Asia which is the largest producer of petroleum products. That destabilises the energy market which has serious consequences for India because we import 80 per cent of our oil requirements. Whenever there is an energy crisis, the Indian economy goes into a crisis. Its BOP is adversely impacted, the Rupee gets devalued, India faces a downgrade from the rating agencies, the cost of borrowing abroad rises, capital flows into the economy decline, inflation tends to rise, the fiscal deficit rises, the govern-ment support to the essentials is curtailed and the poor are adversely impacted. This was the case most recently in 2012.

Brexit has added to the complications for the Indian economy. Many Indian businesses based in the UK will have to relocate to cater to the EU. The downturn widely expected in the UK and the impact on the EU will impact on India’s exports adversely.

These global economic trends are a result of the general Rightward shift in the developed countries due to the crisis of employment, rising incidence of terrorism and the increase in immigration from crisis-ridden West Asia and North Africa. This external instability combined with internal instability has negative consequences for India since the economy is now far more open.


The widespread unhappiness with the ruling dispensation is not only due to social factors but very importantly due to the economy not doing as well as the government is projecting. This article points to the reality of a dichotomous growth with a large section belonging to the unorganised sectors suffering due to the twin shocks administered by the government. While the organised sector has done better, it is at the expense of the unorganised sectors.

The truncation of the autonomy of various institutions in the country—RBI, Niti Ayog, Election Commission, CBI, universities and so on—is undermining democracy and accountability. It is leading to individualisation and partisan-ship. The decline of debate in Parliament and the authoritarian style of functioning have damaged the system of collective responsibility of the Cabinet. This is resulting in mistakes in policy as seen in the decision to go for demonetisation.

The result of the dichotomous growth in India is growing inequality, slowdown of demand in the economy and a low growth rate for the economy as a whole. It has led to the crisis of employment, distress in the farm sector, a lower rate of investment, fiscal problems and so on. In other words, the macro-economic situation is fragile and that undermines the government’s ability to take bold sectoral policy decisions to mitigate the suffering of the marginalised sections.

It is not the argument that nothing has happened in the last four years. Good initiatives like the provision of toilets or cycles for girls have been taken but the overwhelming trend is not favourable for the country.

Because of the rising social and political tensions, the country is passing through a highly unstable phase.This is aggravated by the instability in the global environment. New internally focused policy initiatives to strengthen democratic functioning are needed to overcome the current difficult situation. Slogans will not do and the present dispensation is good at that but the election results point to the fact that one can fool some people all the time but not all the people all the time.

The author, a well-known economist who retired from Professorship at the Jawaharlal Nehru University, New Delhi in the recent past, is currently the Malcolm Adiseshiah Chair Professor, Institute of Social Sciences, New Delhi.

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