Until early 2016, India’s growth had been accelerating when growth in other countries was decelerating. But then the converse happened. The world economy embarked on a synchronous recovery, but India’s GDP growth—and indeed a number of other indicators such as industrial production, credit, and investment—decelerated. Any explanation would need to explain this change in fortunes, this “decoupling” of Indian growth from global growth, identifying the factors that caused India to forge its unique path.
Five explanations suggest themselves.
First, India’s monetary conditions decoupled from the rest of the world. Until the middle of 2016, real policy interest rates were following the global trend downwards. Since then, the downward drift has continued in most other countries, with rates falling on an average by 1 percentage point between July and December 2016 in the US. But in India, for the same period, average real interest rates increased by about 2.5 percentage points. This tightening of monetary conditions contributed to the divergence in economic activity in two ways. First, it depressed consumption and investment compared to that in other countries. Second, it attracted capital inflows, especially into debt instruments, which caused the rupee to strengthen, dampening both net services exports and the manufacturing trade balance. Between early-2016 and November 2017, the rupee appreciated by another 9 percent in real terms against a basket of currencies.
The second and third factors were one-off policy actions: demonetization and GST. Demonetization temporarily reduced demand and hampered production, especially in the informal sector, which transacts mainly in cash. This shock largely faded away by mid-2017, when the cash-GDP ratio stabilized. But at that point GST was introduced, affecting supply chains, especially those in which small traders (who found it difficult to comply with the paperwork demands) were suppliers of intermediates to larger manufacturing companies.
The fourth factor exerting a drag on the Indian economy was the TBS challenge. This has been a drag for some time and its effects have cumulated as the non-performing assets have increased, the financial situation of stressed firms and banks have steadily worsened. During the past three years, profits of the PSBs have plunged into negative territory as provisioning against the bad loans increased substantially. This, in turn, has impaired banks’ ability to supply credit to industry.
The final factor was oil prices. In the last three fiscal years, India experienced a positive terms of trade shock. But in the first three quarters of 2017-18, oil prices have been about 16 percent greater in dollar terms than in the previous year. It is estimated that a $10 per barrel increase in the price of oil reduces growth by 0.2-0.3 percentage points, increases WPI inflation by about 1.7 percentage points and worsens the CAD by about $9-10 billion dollars.