How demonetisation is likely to affect the Indian economy!

Zee Media Bureau

New Delhi: The demonetisation of old Rs 500 and Rs 1000 by the Modi government on November 8 has drawn different views from various experts, economists, political parties and even rating agencies.

Former Prime Minister Manmohan Singh on Thursday warned that the recent demonetisation will reduce GDP growth rate by 2 percent thus harming the country's economy.

Here is a look at how demonetisation is likely to affect the economy and what experts and rating agencies have to say about it.

Economy: What will happen?

1) GDP growth rate is likely to slow down anywhere by 0.5 percent to 2 percent from the last year GDP growth of 7.6 percent for atleast for next 6 months.

2) After a slowdown of 6-8 months the GDP is expected to grow rapidly.

3) More than half of the non-tax paying businesses in the informal sector (40 percent share in GDP) will become unviable and cede market share to their organised sector counterparts.

4) Interest Rates will come down after sometime since the demand for credit will fall.

5) Money supply will fall in the economy as it is estimated that Rs. 3 Lakh crore out of the total Rs 5 Lakh crore will never be converted (this will be a profit to the RBI and the government). This should thus reduce inflation. However if the production is reduced below the fall in money supply then inflation can rise, which although is very less likely.

6) Revenue of the government will rise due to increase in Taxation since black money will be heavily scrutinised and taxed. This will reduce Budget Deficit. When the government will have more money it will be able to spend more on the welfare of people.

What does the Rating Agency have to say on Demonetisation?

1. Goldman Sachs

Negative Impact:

Bad Effect on Post the ‘dramatic currency reform’ the liquidity shortage would be a significant constraint on domestic activity, which in turn would affect GDP growth. “In the short term, the liquidity shortage appears likely to be a significant constraint on domestic activity, leading us to forecast a deceleration in GDP growth to 6.8 percent in FY17 (below consensus), down from 7.6 percent in FY16,”

Positive Impact:

Eventually, the currency reform should help to move economic activity into formal channels, accelerate financial inclusion, and increase government revenue.

We continue to see India as the most promising, with a major currency reform providing an emphatic demonstration of the Modi administration’s reform commitment—albeit at the price of serious short-term disruption.

2. Ambit Capital

On Friday lowered its FY17 GDP growth forecast for India by 330 basis points, saying it expects GDP growth to decelerate from 6.4 percent in the first half of FY17 to 0.5 percent year-on-year in the second half of FY17 with a distinct possibility of GDP growth contracting in the third quarter.

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 (40percent 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 percent YoY (from 7.3 percent.

3. CARE Rating:

Madan Sabnavis, Chief Economist of CARE Ratings said to ETNow

He says India see some pain in the GDP in third quarter as well as fourth quarter, but longer term the recovery is well on track and the economy should recover. "So FY17 GDP number might come down, but FY18 hopefully will not

4. Brokerage Anand Rathi Securities:

India's GDP will decline over the next two quarters due to reduction in overall spending. "After a slow rate of GDP growth for around six months, the subsequent two years could see sharp 'hockey stick' revival in growth

5. Fitch Rating:

Positive:

The surprise move of demonetizations of old Rs. 500, 1,000 has the potential to raise government revenue and encourage bank lending, but at the same time the positive effects are unlikely to be strong and sufficiently enduring to support credit profiles. Impact on GDP growth will increase, the longer the disruption continues.

The move could boost government revenue to the extent that demonetizations helps to move economic activity from the informal to the formal sector, as more earnings would be declared. . It is possible that this positive effect would soon outweigh the drag on revenue collection from lower short-term GDP growth.

Government finances may also benefit from a proportion of high-denomination notes not being traded.

Negative:

The discontinuation of the large denomination notes has led to a short-term disruption in India’s economy. The withdrawal of bank notes has created a cash crunch, with the time spent queuing up outside banks affecting general productivity. Following the announcement, the consumers have not had the cash to complete purchases, and there have been reports of supply chains being disrupted. Also, farmers incapable to buy seeds and fertiliser for the sowing season.

This move by the government could also affect sectors that rely on cash transactions and have a negative impact on bank asset quality. Most importantly, demonetizations is a one-off event. People that operate in the informal sector will still be able to use the new high-denomination bills and other options like gold to store their wealth.

6. HSBC report:

Positive: “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,”.

Negative: India’s economic growth is expected to fall by up to 1 percentage points over the next 12 months in the wake of demonetisation, while longer-term gains will depend on follow-up reforms. 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.

7. Morgan Stanley:

Ridham Desai, managing director, Morgan Stanley India in interview with Reporters said:

Positive: Demonetization will go a long way in cleaning up India and making corruption more difficult, and will be a boost to long-term growth. This will bring about formalization of the Indian economy.

The near-term impact is likely to be negative as India is a very cash-intensive economy—about 12-13percent of India’s GDP (gross domestic product) is cash, and it has not gone as electronic as it ought to and, maybe, this move will force more electronic transactions. Therefore, it is a step in the right direction, despite the negative near-term impact. Replacing $220 billion in cash is not an overnight affair.

Negative: He said,” estimates of unaccounted money lying in cash may be an exaggeration. “To me, a lot of India’s unaccounted income sits in assets, and cash is largely in trade and used for transactions. It is not used to store unaccounted money—it is not a store of value”.

8. Crisil Report:

Positive: The move will have a transitory impact on the Gross Domestic Product (GDP) in a short run and will bring structural benefits to the country’s economy in the long run.

Demonetization can benefit the economy by improving government’s fiscal position, ameliorating (improve) tax to GDP ratio, treading down inflation and driving jobs and income.

The move will have a direct positive impact on tax revenue collection and will improve government’s ability to spend on infrastructure. The cash, currently unaccounted for, will be brought into the banking system for exchange and will eventually be taxed. Declaration of unaccounted income due to demonetisation will be taxed at a rate of 30 to 120 percent, depending on the source. In a long run, the effect on inflation will be neutral.

Negative: The shortage of cash will negatively affect demand in cash intensive sectors such as housing, food and transport. This will exert downward pressure on inflation in a short run.