Earlier this year, things were looking bright for Indian Prime Minister Narendra Modi. Although analysts had predicted a decline in the country’s GDP by 2%-4% because of the fallout from demonetization, GDP growth numbers for the third quarter of 2016-2017 (October-December) came in at 7.0% — enough to maintain India’s status as the fastest-growing large economy in the world.

Since then, it seems that the tables have turned. The growth rate of India’s economy declined to 5.7% in the first quarter of the current fiscal year, and Modi is now under attack by former finance minister Yashwant Sinha, who published an op-ed criticizing the effectiveness of Modi’s government in The Indian Express. “I shall be failing in my national duty if I did not speak up even now against the mess the finance minister has made of the economy,” he wrote. In addition to highlighting the decline in growth, he noted: “Private investment has shrunk as never before in two decades, industrial production has all but collapsed, agriculture is in distress.” Moreover, Sinha added, “demonetization has proved to be an unmitigated economic disaster, a badly conceived and poorly implemented GST (Goods and Services Tax) has played havoc with businesses and sunk many of them, and countless millions have lost their jobs with hardly any new opportunities coming the way of the new entrants to the labor market.”

Opposition parties were quick to jump on the bandwagon. Congress leader Rahul Gandhi tweeted: “Fasten your seatbelt … wings have fallen off our plane.”

But have they?

“There is an old Latin phrase, ‘Cui bono?’ — Who benefits?” says Jitendra V. Singh, emeritus professor of management at Wharton and 2017 fellow, Distinguished Careers Institute, Stanford University. “From any position being taken in public discourse, we should ask, who benefits from this? … I do not believe that the data shows India is in an economic crisis. Yes, GDP growth may have slowed recently. This was to be expected. While the long-term effects of the introduction of GST are going to be quite positive — indeed, some positive results are already showing up in the form of higher tax collections — there was bound to be a short-term disruption.”

“If GDP growth during October-December is under 7%, that would clearly be a worrisome figure. Let’s hope it’s not.” –Kartik Hosanagar

While it makes sense to look at the short-term data, Singh notes, “what really matters is what happens over a period of three-to-five years. Some of the statistics that could be considered if one wants to examine the strength of the economy and foreign confidence in the India story are GDP growth rate, inflation, fiscal deficit, current account deficit, foreign reserves, and FDI inflows.”

Speaking at a function in New Delhi, Modi acknowledged that the GDP growth rate had fallen in the first quarter of the current fiscal. But, he said, it had been much lower in the previous Congress-led regime. Sunil Mittal, chairman of India’s largest telecom service provider Bharti Airtel, told a World Economic Forum meeting in Delhi: “A 6% to 7% growth in any place in the world would be a cause for a great deal of jealousy.”

The International Monetary Fund (IMF) has pared India’s growth forecast for 2017-2018 but expects a revival which will help India win the title of the fastest-growing large economy back from China. The Indian economy will grow 6.7% in fiscal 2018 against the 7.2% estimated earlier, according to the latest IMF World Economic Outlook. Fiscal 2019 growth is projected at 7.4% against the earlier 7.7%.

Disruptions or Trends?

Two days after the Reserve Bank of India issued its monetary policy statement on October 4, RBI Governor Urjit Patel told business daily Mint that “GDP growth would pick up in the third and fourth quarters [of the current fiscal year] to above 7%.”

“If GDP growth during October-December is under 7%, that would clearly be a worrisome figure,” says Kartik Hosanagar, Wharton professor of operations and decisions. “But let’s hope it’s not. In my opinion, the most important GDP measure for the Modi government will be the October-December quarter and the first quarter of 2018. This is partly because enough time would have passed by then so we can separate out short-term shocks because things like GST will be less relevant by then.”

“What is the appropriate time period to evaluate the results produced by a particular policy action?” asks Singh. “Fundamental changes, especially structural changes, take time to fully show results. We should not mistake short-term disruptions for trends. It is a mistake to think that there is some magical, perfect way to run a large-scale complex system like an economy.”

Still, “the growth slowdown is clearly a huge challenge for Modi and his finance minister,” notes Hosanagar. “Even traders and businessmen — some of Modi’s core supporters — seem to be unhappy with the changes they need to make to be compliant with the new GST norms. While the idea of sales tax reform was rather good and very bold, there have been execution challenges. There were similar execution issues with demonetization. The most critical question right now is how much of the decline in the most recent quarter is due to demonetization versus GST versus reduced lending by banks versus impact of prior bad loans, etc.? … [We] need to separate out short-term shocks — which were expected — from long-term impact.”

Meanwhile, Modi claims both demonetization and the GST have delivered. Teething problems linked to the GST and bandwidth constraints may get resolved relatively soon, allowing growth to accelerate in the second half, the RBI noted in its October policy statement. “On the downside, a faster than expected rise in input costs and the lack of pricing power may put further pressure on corporate margins, affecting value added by industry.” The policy left the repo rate (the rate at which the central bank lends) unchanged at 6.0%. India has one of the highest repo rates in the world; in the U.S., it is around 0.80%.

“It is a mistake to think that there is some magical, perfect way to run a large-scale complex system like an economy.” –Jitendra Singh

“There is disproportionate attention being paid in the media to recent events like demonetization and implementation of the GST,” says Ravi Aron, a professor of information systems at Johns Hopkins Carey Business School. “These are, at worst, speed bumps, and neither has any structural impact on the economy.”

The intense focus placed on demonetization and the GST “obscures the real problems that the economy faces – the structural factors, which will stop sustained high rates of growth,” Aron says. “These need to be removed.”

According to Aron, the structural factors that need addressing include the following:

  • The banking system: “Many of the state-owned banks have significant non-performing assets,” Aron points out. “The talk is of consolidating these banks. Instead they should be recapitalized and sold…. In 2016, loans to industry were growing at a meager 2% — a level that cannot support growth rates. Without the debilitating control of the government, these banks will perform their primary function – route capital to where it produces optimal returns and price risk efficiently.”
  • State-owned enterprises: “Every government since Independence has sought to have the state-owned enterprises (SOEs) capture the commanding heights of the economy. This has slowed in 1991 after the reforms, but the Indian economy continues to suffer from the strangulating hold of these SOEs and the capital that they have locked up.”
  • The labor market: “There are over 250 laws having to do with labor and employment. The invidious Industrial Disputes Act has done significant damage to the emergence of an efficient labor market,” Aron says. “About 10% of Indian labor is in the organized sector while the remaining 90% works in the ‘informal sector’ that has no benefits, no pensions or even salary growth tied to inflation. The act prevents retrenchment of labor and makes it highly unattractive to hire employees in the organized sector.”

Adds Aron: “Until we tackle these issues, a more honest name for the ‘Make in India’ campaign should be ‘Make in Spite of India.’”

Gas, Inflation and Unemployment

Apart from the GDP growth, what are additional signals that the economy is not doing well? Investments, for one. Presently, the private sector is facing a wall of unpaid loans. This amounts to Rs.10 lakh crore ($154 billion), which it can’t or won’t pay back — so it has no money to invest. The alternative is for the government to increase spending, through a fiscal stimulus perhaps. But that means widening the fiscal deficit, another bugbear for the critics.

Relaxing the fiscal target may not be the answer. “India’s economic history is replete with the same lessons,” says a report by banking and financial services firm JPMorgan. “Every time policymakers trade off some macroeconomic stability for growth, the economy ends up with neither. The current government has heeded these lessons remarkably well, and shown admirable fiscal restraint. We shouldn’t blemish that record now.”

Many of the other parameters seem to be ticking along. The dollar, after gaining strength against the rupee, has come down. And India’s forex reserves were at a record $402.25 billion as of September 22.

That may pay off later — as will Modi’s broader social schemes, including power for all, spreading the reach of banking, and clean India. But the person on the street is likely thinking more about today’s problems. One is high gas prices: Central levies have kept rates to the consumer high despite falling international crude prices. Another is retail inflation, which in August shot up 3.36% — the highest in five months.

“There is disproportionate attention being paid in the media to recent events like demonetization and implementation of the GST…. [Neither] has any structural impact on the economy.” –Ravi Aron

Jobs are an even bigger concern. One of Modi’s election promises was the creation of 10 million jobs. “The total number of jobs created in the first three years of the BJP government … [is] 1.51 million, nearly 39% less than the 2.47 million created during the three previous years,” according to Hindustan Times. Adds Mint: “The unemployment rate in India has shot up to a five-year high of 5% in 2015-2016, with the figure significantly higher at 8.7% for women as compared to 4.3% for men. The figures could be an alarm bell for the BJP-ruled government at the centre.”

“Modi has a jobs problem, and it could darken his road towards [re-election in] 2019,” says the Economic Times. “The opposition — in disarray since losing to Modi — is dialing up its criticism as it eyes elections.”

“In my opinion, only time will tell whether the ‘slowdown’ will affect Modi’s prospects in the 2019 General Elections,” says Singh. The same goes for predicting how the current challenges will impact the overall economy, he adds. “Instead of hoping to fashion an economic crisis out of thin air, it behooves all to refrain from gratuitous criticism, and focus more on the facts — and to give more time before asking whether a policy or strategy has failed. An economy or society is like a large ship. It cannot be turned in a different direction in a matter of quarters or months. It takes years, if not decades.”