India's GDP growth rate declined to a three-year low of 5.7% in the second quarter of 2017, losing India its status as the world's fastest growing major economy to China. This slowing was attributed to demonetization, GST implementation, and a broader slowdown in private investment, government spending, consumption, and net exports. Structural reforms are needed to boost exports and investment to support stronger GDP growth going forward.

1. Why is India’s
GDP slowing
down?
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2. The GDP growth rate of India declined to a three-year low of 5.7 % in the
March-June 2017 quarter. It was 6.1 % in the last quarter (Jan-Mar 2017).
This is the slowest growth rate recorded in two years and has led India to
lose its status as the world’s fastest-growing major economy to China. The
economists have attributed this slowdown to Demonetization and GST.
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3. • Demonetization was a negative shock to the economy and wiped out 84
% of the cash in circulation overnight. (Read: Demonetization
Explained)
• Uncertainty caused due to GST led to de-stocking of goods ahead of its
implementation on 1st July 2017. Manufacturers/ traders were unsure
as to the tax impact of GST on the goods that were manufactured/
bought prior to the GST regime but remained unsold. They started
destocking or reducing the amount of stock. Hence, the manufacturing
slowed down. (Read: GST explained)
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4. • This slowing GDP cannot be explained solely by the disruptions caused
due to GST and Demonetization. This is because the GDP has been
continuously declining since the last quarter of 2015-16 (Jan-Mar 2016),
much before demonetization was done. (as can be seen from the table.)
Growth Rates of India
Quarter (Year) Percentage
Jan-Mar 2016 9.20%
Apr-June 2016 7.90%
July-Sept 2016 7.50%
Oct-Dec (Demonetization quarter) 2016 7.00%
Jan-Mar 2017 6.10%
Apr-June 2017 5.70%
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5. Growth Rates of India
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
10.00%
Jan-Mar 2016 Apr-June 2016 July-Sept 2016 Oct-Dec (Demonetisation
quarter) 2016
Jan-Mar 2017 Apr-June 2017
Growth rates of India Percentage
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6. • There are four constituents of GDP as per the expenditure method.
Theoretically, the total expenditure must be equal to the total output of
goods and services produced in the economy. (Read: GDP Explained)
• GDP = Consumption expenditure + Investment (Private) + Government
Expenditure + (Exports-Imports). There has been a slowdown in all of
these sectors
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7. Slowdown in Sectors
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8. Consumption
Consumption is the main driver of Indian economy. The growth rate in
consumption declined to 6.6 % in April-June quarter 2017 (Q1) from 8.6
% in April-June quarter 2016. Part of the reason is that consumer demand
was hit as demonetization caused a cash crunch in the economy.
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9. Investment
• Private Investment is measured by the variable Gross fixed capital
formation (GFCF). GFCF as a percentage of GDP has been declining for 5
years now. It grew at a rate of 29.8 % in Q1 as compared to 31 % last
year. The credit flow to the industry has also slowed down due to the
Twin balance sheet problem. (Read: The Twin Balance Sheet Problem
Explained).
• The Government must take steps to resolve the twin balance sheet
problem to effect a strong recovery in the Private investment.
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10. Government
• The Government expenditure has also slowed down. There is a little
scope to increase it without breaching the fiscal deficit target.
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11. Net Exports
There has been an export stagnation and exports grew at 1.2% last
quarter. Export is essential to GDP growth.
Structural reforms will have to be undertaken to enable a robust growth
in exports by improving productivity. In this regard, the RBI can also
intervene to keep the appreciating exchange rate of the rupee in check
which has made imports cheaper and exports more expensive in relative
terms.
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12. Interest Rate
• Interest rates are high in India. A rate cut is necessary to make borrowing
easier. Theoretically, there is a negative relationship between interest rates
and GDP. Therefore, the RBI has to cut interest rates to increase GDP in the
economy.
• Surjit Bhalla has argued that the cause of the GDP decline is the interest rate
policy of the RBI. Inflation is down by 700 basis points since 2013 and the RBI
has cut the interest rates by only 200 basis points.
• The GDP decline has persisted despite conducive macroeconomic
fundamentals namely low inflation, low fiscal deficit, low Current Account
Deficit, high foreign exchange reserves, stable currency and steady foreign
inflows.
• The Government has announced a stimulus package to boost India’s growth.
But, the details of the package haven’t been finalized yet.
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13. References:
No Proof Required: It’s interest rates, stupid
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