India's Prime Minister Narendra Modi. Photo: Reuters/Edgar Su
India's Prime Minister Narendra Modi. Photo: Reuters/Edgar Su

Annualized Indian economic growth for the period April to June 2018 came in at 8.2%. The graph below plots the growth during the years Narendra Modi has governed India as prime minister. It indicates clearly that economic growth in the April-June quarter of 2018 was the highest in more than two years. But what are the reasons for this?

Source: Ministry of Statistics and Program Implementation

First and foremost, the base effect is at work. Base effect is used to calculate inflation in the present year in relation to the prices in the corresponding period of the previous year.

In the April-June quarter of 2017, the economy grew at a much slower pace of 5.59%, the slowest during the Modi years. The ill-effects of demonetization were seen the most during this period. Hence to that extent the economic growth looks much better in the same quarter of 2018.

In fact, if we take a look over a two-year period, between April-June 2016 and April-June 2018, economic growth was much slower at 6.88% year on year. Given this, the base effect is clearly at work.

Second, even with the base effect at work, there are a few good things that need to be highlighted. First and foremost, the non-government part of the economy has grown faster than the overall economy.

The non-government part of the economy grew by 8.28% during the quarter against the overall growth of 8.20%. Even though this is good news, the difference was just 8 basis points – that is, not much. One basis point is one-hundredth of a percentage point.

For rapid economic growth to be sustainable, the difference has to be more than this. The non-government part of the economy, which typically tends to form around 90% of the economy, needs to contribute more. What this also means is that increasing government expenditure continues to play a significant part in driving up India’s economic growth. This is not sustainable over a long term, and has its share of ill-effects.

During the first three months of the 2018-19 fiscal year (April to June), the government had already spent 29% of its budgeted expenditure for the year. In proportionate terms, it should have spent 25%. Given that it has front-loaded its expenditure, in the coming quarters it will have to cut down the pace of its expenditure, in order to ensure that it meets the fiscal-deficit target set at the beginning of the year. The fiscal deficit is the difference between what a government earns and what it spends during a particular year.

Third, what has also helped is the fact that agriculture grew by 5.3% during the April-June 2018 quarter, against 3% during the same period last year. If the economic growth in agriculture continues, it will mean good news for the Modi government, which faces general elections next year. A large portion of the rural workforce in India continues to depend on agriculture for a living. 
Higher growth in agriculture typically tends to lead to an increase in rural consumption expenditure as well.

Manufacturing growth also jumped to 13.46% against a contraction of 1.78%, during the same quarter last year. This, if it remains sustainable during the course of the year, is also good news for the Indian economy.

Interestingly, this jump in manufacturing growth may not have created jobs. The investment-to-GDP ratio during the period was 28.76%. Compare this with a high of 35.61% achieved during the July-to-September quarter in 2011. What this tells us is that the investment scenario in India continues to stagnate and the growth in manufacturing in particular and industry in general has been jobless growth. With the manufacturing sector using less than three-fourths of its installed capacity, this isn’t surprising.

The fact that Indian economic growth is not creating jobs continues to remain a bother.

Also, cash is gradually making its way back into the Indian economy, helping people carry out economic transactions. As of June 30, 2018, currency in circulation was at 11.3% of gross domestic product. This is a huge jump of 250 basis points from end-March 2017, when the currency in circulation stood at 8.8% of GDP. What this tells us is that the cash in the system is working its way toward 12% of GDP, which is where it was before demonetization. This growth of cash has clearly helped the informal sector in general and the agriculture sector in particular, where transactions take place primarily in cash.

To conclude, the Indian economy seems to be coming out of the ill-effects of demonetization and a botched implementation of the goods and services tax (GST). In this scenario, the economic growth in the coming quarters should remain firm. Of course, which way the global price of oil goes and the depreciating value of the rupee against the US dollar remain the jokers in the economic-growth pack.

Vivek Kaul

Vivek Kaul writes on the economy and finance. He is the author of the "Easy Money" trilogy and India's Big Government. He tweets as @kaul_vivek

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