GDP contraction: Bad result of well-intended reforms?

With the release of the latest GDP figure by the National Statistical Office that showed a contraction of 7.3 per cent in 2020-21, the obvious question is that what might have contributed to the contraction in over four decades. It is true that the COVID had played a major role in pulling the economy down but that is not alone the reason for the fall. Even before the pandemic began gnawing economic stability, the economic health of the country had not been sound for the last few years.

To understand the situation better, it is important to analyse various economic fundamentals that play vital roles in the economy. From the 1990s to the pandemic hit time, the Indian economy has shown a study growth of an average of around 7% every year. However, the growth rate has been wavering since the Modi government took office in 2014.

The data of the fundamentals has shown the economic activities have not been normal in the last six years due to the impact of the financial reforms the Central government has brought in with the intention to clean out the malpractices that existed in the system. Among the reforms, demonetisation and the Goods and Service Tax did the worse in the economy. The subsequent financial mayhem that the country witnessed following the implantation of the reforms naturally arises a question was the country mature enough to devour the reforms that have been brought out to finish the market wrongdoings?

By the introduction of the GST, the existed state-level taxes and the Central taxes, including the cess, had been abolished, and got a unified tax levying system, conferring on the Central government the power to decide on the different slabs of taxes. The declaration of the demonetisation without any prior notice, making well-flown and well-circulated higher denomination currencies invalid at once, was an irreparable blow to the country's economy. The hard cash transactions, the blood which kept alive the market by running across the industries, have gradually lost to the digital transactions that in turn failed traders' confidence.

Couple with the blow the reforms brought in, the increasing fuel prices by the state-run oil companies added pain to the already ailing economy. The cost of goods transportations doubled due to the unbridled auto fuel prices, causing an inflation rate above the target.

Meanwhile, some economists made frequent commentaries about a recovering and strong economy referring to the fundamentals of the economy. They often claimed that the fundamentals of the economy are sound. But are really the economic fundamentals sound? Gross Domestic Product, unemployment, inflation and fiscal deficit are the common economic fundamentals that determine whether the economy is sound or not.

GDP Performance

When going through the GDP figures in the last seven years, there had a growth after a fall caused by the Global Financial Crisis in 2013. But this growth took a slower pace since the demonetisation in 2016. About 86% of currencies that had been spread across as legal tender became invalid. The demonetisation and short-sighted implementation of the GST has further worsened the banking system that was reeling under massive bad loans, ensuing in a GDP fall of 4% in FY20 from over 8% in FY17.

Again in January 2020, the GDP growth fell to a 42-year low. An examination of the fundamentals would clearly suggest that the economy was in weak condition well before the COVID hit the country.

Unemployment Status

The country's unemployment rate was at a 45-year high in 2017-18 after demonetisation and the GST implementation. In 2019, the data showed that the total employed people in the country were about 9 million, marking the worst figure in the total employment in independent India. The subsequent reports after that showed the country recording nearly 6%-7% un-employability to the COVID era and the unemployment rate has since been seen further declining. Given the figures, unemployment would be the biggest threat the government to deal with in the course of overhauling the economy.

Inflation at Play

The government could manage to keep the inflation at its target level in the first three years thanks to low crude prices in the international market. The crude prices fell to just $85 in 2015 and further to below $50 in 2017 and 2018. This fall benefited the government to maintain the inflation rate. However, the gradual fall of the economy caused by the reforms, thus diminishing the tax revenue prompted the government to benefit crude prices fall by adding extra taxes on the basic fuel prices. Despite the Reserve Bank of India's effort to keep the inflation rate in control by cutting repo rates to banks several times, the inflation remained high.

Part of Fiscal Deficit

The fiscal deficit is one of the key elements in determining the health of the economy. The government often borrow money to meet its expenses. This borrowing, however, creates an adverse impact on the market. The government burrowing will reduce the borrowing capacity of the private business, automatically raising the interest rates on loans for private business. Besides, borrowing increases the debt burden on the government and the government, in turn, pass this burden to the taxes, which would push the inflation rate up. The data on the real fiscal deficit is unavailable but the government claims that it is under control.