After Drastic Withdrawal of Cash Supplies, Pain and Gain for India’s Economy: Analysts

As a cash crunch grips India, a commonplace picture now in the country is long queues outside bank branches and ATMs, frowning faces of small business owners and stranded tourists.

But analysts argue that though they see short-term pain for India’s economic trajectory but the unseen impact of the government’s decision to wipe out 86 percent of the total value of currency in circulation to fight corruption and counterfeiting goes deeper and eventually deliver long-term gains.

Replacement of 500 and 1,000 rupee banknotes by new 500 and 2,000 rupee denomination notes was announced in a surprise demonetization move that caught most people off-guard on Nov. 8, by Prime Minister Narendra Modi.

But the cash-intensive areas of the economy, including everyday shopping for food and supplies, have already been disrupted by the government’s demonetization effort.

About 60 percent to 80 percent of India’s consumption basket is cash-intensive, including food, transport, real estate and restaurants, HSBC’s chief India economist, Pranjul Bhandari, said in a note. “We assume that growth for these components halve on the back of the monetary shock,” Bhandari wrote. A lowering of 0.7 to 1 percentage point to the India’s full fiscal year gross domestic product (GDP) growth is expected by her.

Bank of America Merrill Lynch (BAML) research analyst Sanjay Mookim estimates India’s burgeoning shadow economy at 25 percent to 30 percent of GDP and this is one of the chief target of Modi’s demonetization efforts. A “much slower consumption,” especially once a new India goods and services tax (GST) kicks in next year could result from the immediate impact on the black economy, Mookim said in a note.

This move could bring some of the black money into the formal economy over time as this would cut the supply of black money circulating the economy, said analysts pointing out that there could still be some beneficial outcomes. Secondly, according to analysts from Singapore’s DBS Bank, if it succeeds in “unearthing unaccountable money” from the shadow economy, the government could see tax gains.

India’s official and effective money supply has a growing divergence. The latter referred affects the overall demand for goods and services and is the amount that was available for carrying out daily financial transactions.

A near-term decline in consumption demand is expected to be suffered by sectors that relied heavily on cash transactions, including real estate, construction, gold, gems and jewelry as well as the informal sectors.

“Small and marginal farmers in the fruits and vegetable category typically require off-loading of their produce in the local mandi (wholesale market) in cash and could see an immediate impact,” according to analysts from India Ratings and Research (Ind-Ra).

There can also be a hot to the services sector, which BAML’s Mookim pegs at 61 percent of India’s GDP. “The current disruption is not a postponement of income, but is lost revenue,” he explained. He added that the impact on consumption will outlast the physical cash shortages.

A drop in consumption would push growth lower unless compensated by gains in fiscal spending and trade gains given India’s companies have been more conservative with their investment plans given the slowdown in the economy as well as their bad debt problems.

(Adapted from CNBC)

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Categories: Economy & Finance

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