Life After Demonetisation: Taking Stock Of The Economy

Fifty days after the government withdrew 86 percent of the country’s currency from circulation, there is still little to go on while trying to assess how the economy will change as a result of that decision. The short-term response to the cash crunch, however, is starting to come through in high frequency data indicators from across different sectors and agencies.

The November 8 decision to scrap Rs 500 and Rs 1,000 notes led to severe shortage of currency. While Rs 15.4 lakh crore was withdrawn as a result of the decision, only about Rs 6 lakh crore in new currency has been put into circulation.

Leading Indicators Point To GDP Slump

Leading indicators compiled by Nomura Global Market Research and SBI Ecowrap both point to a slump in near-term economic activity.

The Nomura Composite Leading Index, which tracks non-agricultural GDP growth with a two-quarter lead, is pointing to a sharp slowdown in the first half of 2017, the financial services major said in a report on December 21. The index has fallen to a level not seen since the series started in the second quarter of 1996, it added.

The Reserve Bank of India’s official growth estimate for the year stands at 7.1 percent, lower than the earlier expected 7.6 percent. Most private forecasters, however, are expecting growth to be lower than that.

State Bank of India’s near-term composite index, which forecasts near-term industrial activity, crashed to an all-time low of 45.5 year-on-year, compared to last month’s revised level of 50, the bank’s economic research department said in its newsletter Ecowrap on December 26.

“As per the Index, we believe industrial output growth may continue to remain in the negative territory in December 2016,” it said. Industrial output data for November is due on January 12. In October, industrial activity contracted by 1.9 percent.

Consumption Slides But For How Long?

The extent to which consumption takes a hit will be key in determining how the economy fares over the next couple of quarters. The Indian economy, for the last two years, has been largely supported by government spending and consumption while private investment has been nearly absent. Demonetisation threatens to hurt consumption, which, if it lasts long enough, could further delay any recovery in investment.

One indication of the hit to consumption came from market research firm Nielsen, which says that the fast moving consumer goods sector saw a 1.2 percent net negative impact on consumer sales in value terms. “While a 1-1.5 percent net impact of demonetisation does not look huge, with the size of the FMCG industry at Rs 2.56 lakh crore, this is a large drop in absolute value terms,” said Nieslen in a report released on December 23.

In trying to assess how long the hit on consumer spending will last, Nielsen conducted a consumer sentiment survey between November 25 and December 1. The survey showed that about half the consumers have cut down their household spends significantly.

Across other consumer segments, such as the auto sector, sales in November slowed but comments from some industry executives suggest that the scenario has improved in December. According to data from the Society of Automobile Manufacturers (SIAM), total sales fell 5.48 percent in November, the steepest decline since March 2013. However, on December 23, RC Bhargava, chairman of Maruti Suzuki India Ltd. told PTI that bookings in December have risen by 7 percent.

Also Read: Assessing Impact Of Demonetisation Remains A Moving Target: Gita Gopinath

Agriculture Scrapes Through Demonetisation

While consumption, both urban and rural, is likely to take a hit at least for a couple of quarters, fears of a hit to agricultural output may have been unfounded.

The severe cash crunch in the immediate aftermath of the demonetisation decision had crimped the ability to purchase seeds and inputs for the Rabi season. To prevent this, banks had been asked to push supply of cash to agricultural areas. On 17 November, the government also eased the withdrawal limit for farmers to Rs 50,000.

NABARD (National Bank for Agriculture and Rural Development) also made available Rs.21,000 crores to the District Central Cooperative Banks through State Cooperative Banks for Rabi agricultural operations.

The measures seem to have prevented any hit to sowing.

Some segments of farm sector, in particular, perishables like fruits and vegetables did take a hit in the immediate aftermath of demonetisation. Retail inflation data for November showed that inflation in the food and beverages category slipped to 2.56 percent in November compared to 3.71 percent in October. This, however, may normalise as supply of currency improves.

Savers Set To Lose Out While Borrowers Gain?

One factor that could boost sentiment in an otherwise subdued environment are lower lending rates. In contrast, savers may actually be hurt as deposit rates are set to fall.

Following the government’s decision to demonetise, bank deposit growth has surged to above 15 percent. Loan growth, meanwhile, has fallen sharply to just above 5 percent.

The wide gap means that banks will look to cut deposit rates once the flow of deposits stabilizes. While fixed deposit rates have already come down, bankers are now hinting at a possible cut in the savings deposit rate as well. The fact that a bulk of the old currency deposits made by citizens are sitting in savings accounts gives banks enough reason to justify a cut in the savings deposit rate.

Since lending rates are now linked to the marginal cost of funding, a cut in deposit rates will likely lead to a drop in lending rates too.

Also Read: Now, Demonetisation May Eat Into Your Savings Account Rate

Is The Fiscal Deficit Set To Fall?

The assumption is that demonetisation will be positive for the government’s finances in the medium term.

In the short term, trends in tax collections have remained steady, at least until last month. According to a December 29 PTI report, indirect tax collections in November rose 23.1 percent to Rs 67,358 crore. As such, economists are sanguine about the government’s finances and, in fact, expect demonetisation and the related income disclosure scheme to boost government collections.

In a research note dated December 20, Bank of America Merrill Lynch said that the collections from ‘Income Disclosure Scheme II’ could help the government meet next year’s tough fiscal deficit target of 3 percent. In addition, the possibility of a special dividend from the Reserve Bank of India to the government remains on the horizon.

Note: This story has been amended to correct an error in the graphic reflecting credit and deposit growth data.