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Demonetization Pushes India Back A Few Months In Its Quest To Surpass The UK's Economy

But this is not necessarily a bad thing.

23/01/2017 4:58 PM IST | Updated 24/01/2017 8:46 AM IST
Mukesh Gupta / Reuters

My article on India's GDP surpassing that of the UK has received much attention both in India's domestic media as well as in the foreign press. A recent macroeconomic event, namely demonetisation, has led to updated estimates for India's GDP, which in addition to some minor currency fluctuations, merits revisiting parts of my analysis. My original article had identified the potential for these types of variations to happen, and stated that once economies reach rough equality, what matters more are future growth prospects, where India has clearly surpassed the UK. Still, if you're interested in the exact date of when India will surpass the UK's economy, it is likely to be somewhere near September, 2017.

Should we sacrifice some GDP growth if it augments government finances that can be spent for the benefit of the neediest sections of society?

The data source I used for India's nominal GDP is IHS Markit, a well-reputed source on global macroeconomic data. The ₹153 trillion estimate for India's 2016 GDP in my previous article comes from their 15 October 2016 forecast for India's 2016 GDP. Note that there is a natural lag between the time a report is crafted and date of publication, which creates the opportunity for these figures to change. IHS Markit's 15 January forecast now estimates India's 2016 GDP to be ₹149.3 trillion, pushed downwards due to a fall in inflation and some decrease in Q4 GDP, both driven by demonetisation. This is in line with 2016 estimates from The Hindu. Similarly, there have been some currency fluctuations during this time, with the Indian Rupee moving from ₹66.6 per US$ to 68.1 today (22nd Jan close), likely due to an increase in interest rates by the US Federal reserve. The UK GDP estimate and GBP/USD figures are similar to my previous article.

Source: IHS Markit, Office of National Statistics UK, Capital IQ, Author's calculations

So by combining the two, where do we arrive at? India's 2016 economy of ₹149.3 trillion converts to US$2.19 trillion at an exchange rate of ₹68.1 per dollar and UKs GDP of £1.87 trillion converts to US$2.29 trillion at an exchange rate of GBP 0.81 per dollar. The economies are about 100 billion dollars apart. India is expected to grow in real terms by 7.2% in 2017, with the UK expected to grow at 1.1% according to the IMF. India therefore enjoys a differential growth rate advantage of 6% for 2017 and should therefore take about nine months to close this gap. The implicit assumption is that currencies will evolve based on relative purchasing power parity, and therefore what really matters is the real growth rate. The key takeaway here is that there is bound to be some noise in comparing the market GDP of two dynamic countries. But, at the same time, there also a clear underlying signal beneath the noise that is worthy of identification.

Source: IHS Markit, Office of National Statistics UK, Capital IQ, Author's calculations

Is this article then just some more bad press for demonetisation? I would argue to the contrary, based on demonetisation's potential positive impact on long-term growth rates, and more fundamentally, based on the purpose of economic reform and the potential drawbacks of GDP as its sole metric of evaluation.

There is still a great amount of uncertainty regarding demonetisation's long terms impact. But one positive area that is worth highlighting is that it might increase India's growth potential through increased financial intermediation. The crux of this argument is that the financial sector is much better able to allocate capital than private citizens whose allocation of capital is limited by their own personal networks, and might even lead to very unproductive uses such as leaving cash idle. Demonetisation has already achieved this to some extent by significantly increasing the amount of bank deposits, as well as increasing the volume of digital transactions. This argument dates back to Schumpeter from 1911 that is also thankfully supported by robust evidence from our current millennium. In fact, a high level of financial intermediation has been one of the key success factors of China's rapid growth.

We have waited for 150 years to surpass the economy of the UK—what's another nine months?

One of the criticisms of unfettered capitalism is that it focuses too much on short-term results. It can lead to managers sacrificing financially viable projects, just so that they can meet earnings expectations. A similar criticism could apply to quarterly GDP figures for nations, and therefore a single-minded pursuit of GDP can oftentimes make us lose sight of the long term. Another dimension that nations have to think about is distributive effects of growth. This is important as demonetisation impacts those with more cash to a higher degree than those with less cash. Should we sacrifice some GDP growth if it leads to more equal distribution of wealth? Should we sacrifice some GDP growth if it augments government finances that can be spent for the benefit of the neediest sections of society? These are questions worth thinking about.

For these reasons, I view this slight update to India and UK's economic story caused by demonetisation, as not necessarily being negative. We have waited for 150 years to surpass the economy of the UK—what's another nine months?

Old Bangalore

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