Wrong, Dr. Rajan

Why Dr. Raghuram Rajan is wrong about note ban and GST

In many ways Dr. Raghuram Rajan has been the equivalent of an Elvis Presley of central banking. With him around, there was never a shortage of spoken words or decisive action. To his credit he did manage the near external crisis in 2013 appreciably. However, he may have gotten his views grossly wrong when he blames GST and note ban for the weak GDP growth in India.

New Hindu rate of growth

In an interesting analogy, Dr. Rajan has called 7% growth the new Hindu rate of growth for India. It used to be 3.5% in the old days prior to liberalization. While that can still be debated it is wrong to say that 7% plus growth is really bad. It is hard to think of one country that is growing at over 7% annually in these conditions. To be fair, there are some countries in Africa and Central Asia that are showing that kind of growth but in India we are talking about a GDP base of $2.65 trillion. Our neighbor, China, is struggling to grow at 6.5% and has already warned of an impending slowdown in GDP growth. This is in comparison to a sustained growth of over 10% for over 20 years. Also, it is not practical to expect that kind of GDP growth in India when the world GDP is likely to grow at just over 3.5% even by the most optimistic estimates. India would need time to resolve its banking mess and also to realize the full benefits of GST. To call 7% as a new Hindu Rate is grossly erroneous.

Did demonetization do it?

To be fair, the growth has fallen by less than 100 bps since the demonetization. What we are ignoring is the likely negative repercussion on industrial credit if banks had not been flush with liquidity. Banks became flush with money only due to demonetization as it put nearly $200 billion into the coffers of the banks. In one shot, this move ensured that the gap in transmission of rate cuts, which Dr. Rajan complained about, also got reduced to zero. Of course, credit growth did not pick up in a big way but that was more because Indian industry was operating with a capacity utilization rate of 70%. The production and growth happened without any worthwhile credit demand or capacity expansion. In fact, it was the note ban that smoothed the liquidity concerns of banks in a big way!

Why blame GST for growth?

It also does not make eminent sense to blame GST. It has started the gradual formalization of the unorganized sector, expanded the tax base and improved compliance. To that extent, GST was a policy investment made by the centre and its fruits would be more visible in the months and years to come. Growth slowdown is a global phenomenon and India cannot be divorced. To say that it was caused by demonetization and GST is not only rich but also a clear distortion of the economic truth!