Impact of Demonetization on Indian Economy

Even as the demonetization drive was in full swing during the months of November and December, the media was full of scary reports. It was predicted that the cash crunch caused by the demonetization drive will suppress liquidity, subdue demand and force a downside in the overall business cycle. As data points finally start to emerge, a lot of the brouhaha over the demonetization seems to have been largely exaggerated. Or perhaps, the likely outcome was never really understood. Check this out…

Very small dent on GDP… 

If the latest RBI policy is any indication, then the dent on GDP for the full year is likely to be minimal. The CSO had estimated full year GDP at 7.1% without considering impact of demonetization. The RBI, in its policy has pegged full year GDP at 6.9% after considering the impact of demonetization. That is almost a negligible difference. One can argue that this is lower than the 7.6% estimated originally; but that estimate was ambitious and flawed in the first place. The weak demand was anyways visible quarterly corporate numbers even before the cash crunch. The Niti Aayog’s full-year estimates of 7.6% were aggressive to begin with and that was already visible from the RBI’s more conservative estimates. If we are talking about a mere 20 basis points fall in GDP growth, then it is likely that the side effects have been simply overestimated!

Why bet on the fourth quarter? 

GDP estimates for the full year are quite aggressively betting on a revival in the fourth quarter of fiscal 2016-17. There are a few distinct reasons for this. Firstly, the re-monetization is picking up steam and by mid-February, the liquidity mismatch should be largely resolved. Secondly, the $200 billion surge in bank deposits is likely to result in a sharp cut in lending rates and a surge in borrowings. This will also have an accelerating impact on growth. Thirdly, there have been certain clear dividends from demonetization. The color of money in the economy has surely become less murky and the tax base is likely to be widened. The government could be the trigger for growth in the next few quarters. 

It will boil down to the follow-up…

At the end of the day, the success of the demonetization drive and the ability of GDP to bounce back will depend on follow-up action. The government needs to sustain its pressure on black money. It has to be followed up with next steps on benami properties, bringing back black money stashed abroad, continue the thrust on digitization etc. if the government can keep up the momentum; and the budget has given adequate indications, then it will be a logical progression. Demonetization pains will be forgotten and the revival will be much sharper than expected! ©

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