How Demonetisation Move Instils Speed Breakers For India’s GDP   Nov 23, 2016


As the cash-rich Indians have become cash-starved, the economy now runs a severe risk of a slowdown. The routine of crores of Indians changed soon after the radical announcement of demonetisation of old Rs 500 and Rs 1,000 notes came out. Nearly two weeks hence, urban life seems to be getting back to normalcy, albeit slowly, but 6 lakh villages in India are still struggling with the cash crunch.

The decision to scrap nearly 86% of India's currency has received a mixed response. Some treat this as a revolutionary step that would help fight with the devil of black money more efficiently, while others are sceptical about the success of this decision. Under such uncertain times, people tend to delay their buying decisions until they get clarity on everything—price trends, their future income and interest rates.

Empty pubs in Delhi-NCR, slack in some of the busiest consumers' markets across the country, less crowded restaurants and shopping malls narrate the whole story. Without any doubt, Indian economy is cooling off, how long this phase will last is a real question.

Before the demonetisation came in effect, India was perceived to be leading the global growth engine. International Monetary Fund (IMF) had recently revised India's estimated GDP growth for FY 2016-17 from 7.4% to 7.6%.

Justifying this revision, IMF had noted that

"India's economy continued to recover strongly, benefiting from a large improvement in the terms of trade, effective policy actions, and stronger external buffers, which have helped boost sentiment."


In the wake of demonetisation, India’s domestic trade is bound to suffer shocks. Now it just remains to be seen by how many percentage points IMF cuts its forecast for Asia’s third-largest economy. It expects China to grow at 6.6% this year.

Rough estimates of other market observers suggest that India’s GDP growth is likely to slip below that of China. However, Government of India seems to be ruling out any such possibility, at least for now.

Expressing more optimistic view Mr Shaktikanta Das, Economic Affairs Secretary said, “It is too early to assume GDP will go down just because of this. The situation will ease out in next 10 to 15 days.”

Looking at the situation at the grassroots level, it appears that, his claims are more of hopes than a realistic assessment. At the fifth bi-monthly monetary policy review scheduled on December 7, 2016, RBI is likely to revise its GDP estimates downwards. RBI has projected 7.6% growth in FY 2016-17.

As remains the question of other market observers, experts and economists, their opinions and judgments vary to a great extent. The most bearish estimates have come from Ambit Capital, a global investment bank. It expects a contraction in economic activities in Q3FY17. As per its assessment, in the second-half of the current fiscal year, India’s economic growth may reduce to 0.5%. This translates into 3.5% for the entire year. It had earlier predicted a full-year growth of 6.8%. Further to this, it has sharply revised the FY 2017-18 estimates as well, from 7.3% to 5.8%.

Research note of Ambit Capital says… 

"The demonetisation-driven cash crunch that is playing out in India will paralyse economic activity in the short term. We expect a strong 'formalisation effect' to play out as nearly half of the non-tax paying businesses in the informal sector (40% share in GDP) will become unviable and cede market share to their organised sector counterparts. We expect this dynamic to crimp GDP growth in India in FY18 as well and hence we have cut our FY18 GDP growth estimate to 5.8 per cent YoY (from 7.3 per cent)."


Independent credit rating agency, CARE, expects a fall of about 0.3% to 0.5% in FY 2016-17. In its special report, 'Impact of demonetization on GDP growth in FY17’ it has noted that the services sector is likely to receive a severe biting in Q3. However, it expects this situation to get reversed in Q4. The Agency also expects Small and Medium Enterprises (SMEs) to suffer the most. It’s noteworthy that, CARE had placed a target of 7.8% earlier, 20 bps higher than IMF’s estimates.

On the other hand, financial services giant, HSBC has predicted about 1% drop in India’s economic growth. In its note, it has mentioned that “Using the cash elasticity of GDP, we estimate that over a year, economic growth can fall by 0.7-1.0 percentage points, with the maximum impact in the immediate two quarters, which will see a large contraction in ‘effective’ money supply”

It further added, “If the government follows up with a spate of reforms, gains can be immense, as the parallel economy moves towards official. As the saying goes, ‘well begun is half done’. But the other half needs work.”

Without quoting any number, Christopher Wood, Managing Director and Chief Strategist, CLSA also pointed at a possible slowdown. He said, “If the private sector investment story remains constrained, areas where the cycle has already picked up in terms of consumption now face some short term setbacks because of the knock-on contractionary effects of Modi’s attack on cash. Examples are autos and cement...Hopes of a revival in rural demand driven by India’s best monsoon season in three years will also be deferred.”

On numerous occasions, Credit Suisse, a leading global financial services company, has highlighted that cash purchases account for more than 90% of overall transactions in India. Moreover, it says, nearly 90% of India’s population works without a job contract. This gives an idea about difficulty Indian economy is likely to face in the near term. Unless the infrastructure for digital payments is ramped up fast, recovery might get delayed longer than expected.

What to expect?

GDP data for Q2FY17, will be announced towards the end of this month. The effects of demonetisation won’t reflect in numbers. However what remains crucial is to see how next two quarters pan out for the Indian economy. The extremes of estimations coming from experts should sum it up for you. Even experts appear as clueless as the common man is about the future.

PersonalFN is of the view that, investors shouldn’t speculate on GDP numbers or try to predict India’s growth rate for quarters to come. On the contrary, you should take some time out to monitor the performance of your investments. It’s a time to revisit your portfolio, just to check whether your current investments are still in line with your investment objectives and personalised asset allocation. While you reshuffle your portfolio in the wake of changing macroeconomic situations, always consider your risk appetite as an important determinant.

Do you think Indian economy will have a long-drawn-out phase of economic lull or it’s just a passing stage? Share your view here Facebook | Twitter 

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