Two shocks hit the unorganised sectors

So, where does the problem lie? It is that the method used to estimate the quarterly rate of growth of the economy does not give the correct rate of growth when there is a shock to the economy. Demonetisation was a major shock to the economy and especially to its unorganised components. Demonetisation set into motion a long term trend of slowdown in the economy. This is still playing out.

This shock was followed by another shock due to GST, which led to huge uncertainty. Not only is its implementation poor, but its design is faulty too. It is intended to benefit the large-scale sectors at the expense of the unorganised sectors of the economy. But as it is implemented, it has damaged the prospects of the large-scale sectors too. Thus, GST has set into motion a further slowdown in the economy.

Some analysts argue that GST will result in the formalisation of the unorganised sector, which will benefit the economy. But the large unorganised sector exists because of its scale, which makes it difficult for it to function like the formal sector. It is a structural problem that will not go away because the government wants it to. It can only damage this component of the economy. So, the argument of formalisation amounts to saying that these businesses would die out and be replaced by the large- and medium-scale businesses in the formal sector. I argued why this would happen even though businesses with a turnover of less than Rs 20 lakh are exempt from GST and those with a turnover of between Rs 20 lakh and Rs 75 lakh have lower tax obligation under the ‘composition’ scheme, which is turning out to be rather complex.

Need for new methodology

The official document, Methodology For Estimating Quarterly GDP, states:

The production approach used for compiling the Quarterly Gross Value Added (QGVA) estimates is broadly on the benchmark-indicator method.

A key indicator or a set of key indicators for which data in volume or quantity terms is available on quarterly basis are used, to extrapolate the value of output/value added estimates of the previous year.

In general terms, quarterly estimates of Gross Value Added (GVA) are extrapolations of annual series of GVA.

What does this imply? Because data is not the available “benchmark-indicator” and extrapolation of “the value of output/value added estimates of the previous year” has to be used.

Two points arise.

First, benchmark indicators are calculated once every few years when data becomes available from surveys. These are not updated continuously because there is not data to do so. Hence, when there is a big shock to the economy and the economic ratios change dramatically these indicators are no longer valid. If used, they lead to erroneous growth rates.

Secondly, extrapolation is invalid when the economy is severely disturbed, like due to demonetisation.

The ‘benchmark indicators’ and ‘extrapolations’ are valid only for the normal functioning of the economy, which was certainly not true after November 8, 2016. What was valid on November 7, 2016, is not valid after November 9, 2016, so extrapolation cannot be used. In brief, the methodology for estimation of quarterly growth rates needed a drastic change both after November 8, 2016, and after July 1, 2017.

An illustration would make this clear. The government’s press note said:

GVA from quasi corporate and unorganised segment has been estimated using IIP (Index of Industrial Production) of manufacturing.

IIP represents the growth in the organised sector. In normal times it can be used to indicate the growth in the unorganised sector. But after demonetisation when the unorganised sector contracted sharply and the organised sector was affected less, not only the ratio between the two changed the IIP growth rate was no more representative.

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