Will demonetisation slow growth in the short term?

The fastest-growing economy in the world may trip due to its bold crackdown on unaccounted for money that almost overnight made a big chunk of its currency illegal. On November 8, India announced that Rs. 1000 and Rs. 500 currency bills will cease to be legal tender and experts say that could impact the economy adversely in the short-term.

Consumption

One of the biggest drivers of India’s growth is the consumption story of its 1.2 billion people. The cash crunch is expected to hit consumer demand as millions of people rush to exchange or deposit the old currency bills in their bank accounts.

“The sudden decline in money supply and simultaneous increase in bank deposits is going to adversely impact consumption demand in the economy in the short term. This coupled with the adverse impact on real estate/construction and informal sectors may lead to lowering of GDP growth,” said credit ratings agency India Ratings & Research.

While it mentions that the pain is likely to be confined over the short term and that the system is likely to readjust to change soon after, however, the ratings agency maintains its GDP growth forecast for India as 7.8% for FY17 with a downward bias.

Real Estate

The real estate sector in India is notorious for cash dealings and an easy avenue to channel black money. Since the demonetization aims to weed out black money the real estate sector, especially the luxury segment will take a hit.

“The demonetization move is likely to result in luxury property prices dipping by as much as 25-30% as sellers struggle to offload properties to generate liquidity,” said Ashwinder Raj Singh, CEO – Residential Services, JLL India in a statement.

The company further notes that resale properties that typically have a high incidence of cash dealing could get impacted. Residential projects in smaller tier 2 and tier 3 cities that rely on cash for primary sales too will slump in the short run.

Liquidity

Over 3 trillion rupees or over $44 billion in old currency has been deposited with Indian banks in just the first week of this move. Would that translate into a huge liquidity deluge for the system? Apparently not immediately.

Brokerage Kotak Institutional Equities said that based on anecdotal evidence operational delays would lead to only 40% of the 3 trillion rupees gets translated into liquidity for the banks. The rest of the amount would become a part of the system only after a few days.

Over the longer term, as the banks’ deposit base expands so will their lending capabilities. A clamor for lowering interests has already begun.

“Given the change underway, there could be some squeeze of liquidity for a while before things normalise. This is expected. However, to counter any downside impact on the level of economic activity, FICCI would urge the Government and RBI to consider bringing down the interest rates that could help stabilise the demand in the economy,” said Harshavardhan Neotia, President of the industry body Federation of Indian Chambers of Commerce and Industry (FICCI).

Coupled with the downward trajectory of interest rates, a pick up in lending activity could boost industry and businesses and spur that could in turn spur consumption demand.

The Bottom Line

Uncertainty and cash squeeze in the short term will not just impact Indian citizens as they queue up outside of banks but will also take some momentum off the Indian economy. But experts believe slight slowdown will only be short-lived and that the economy will rebound once the systems adjust to the new normal.

Credits Investopedia

Leave a Reply

Your email address will not be published. Required fields are marked *