A little over a year ago, banks, companies, government departments and ordinary people were frenetically trying to adjust to the extraordinary step taken, of overnight “withdrawal of legal tender status of specified bank notes” amounting to 85% of outstanding currency. The release of the GDP growth data for Q2FY18 marks something of an end for the progressive slowing down of growth, a trend that has accompanied the demonetisation exercise. This article looks more at the journey of India’s economic, financial and payments structure since November 2016, rather than the growth trajectory for the coming quarters. First, though, a brief look at the growth recovery in Q2FY18, which was fairly broad-based across segments (compared to a couple of previous quarters) and, importantly, led to by non-government manufacturing (and, to an extent, services). The manufacturing segment, in particular, seems to have recovered sustainably; the persistence of better numbers suggests that this is not a dead-cat-bounce after GST. There seem to be the first signs of investor interest in some capex projects. We forecast that H2FY18 growth is likely to be 7% plus, and the twin balance-sheet problems will get gradually mitigated.
Multiple structural changes have happened, or been catalysed and accelerated, including formalisation and financialisation of household savings, a jump-up in retail digital payments, higher tax compliance, among others, and these are changes which will impact transaction, savings and economic behaviour in future. This article attempts a limited analysis of near-term economic effects of the changes, primarily on the real economy, including consumption, production and jobs.
It is difficult to attribute elements of the current economic environment to the extraction of high-value currency notes. There have been multiple changes in policies, institutions and structures both in the run up to and the period after demonetisation. But there are some indications of changes in trends and behaviour, though each depcition of the these changes has layers of complexity built in that are difficult to detail in this brief article. On the real economy, the trends and impact have been mixed. Business seems to have largely shrugged off even the expected disruption due to GST, based on both RBI surveys as well as output indicators.
PMIs show that demonetisation had an impact, though transient, but output systems have been hit by the ongoing process changes in the run up to GST. The same narrative is evident even in the Index of Industrial Production (IIP)—for a sharp dip recorded for a couple of months—before other pre-GST commercial considerations became important. The striking impact seems to have been on consumer durables. The other segment which has decelerated is intermediate goods—the inputs into future production.
But this seems to have been a prelude to GST rather than a DeMo effect. Corporate results on sales and operating margins show that services segment growth slowed sharply (due to disruption in construction, trade and other cash-intensive segments) and operating margins took a hit across the board. However, RBI’s House Price Index does not show any particular distress in housing.
Job growth, on the contrary, seems to have jumped in the October-December 2017 period—with the manufacturing sector contributing the most. It is not clear if this addition was prior to November, but the pattern of job growth in the other seven segments reported (particularly, construction and trade) suggests that this did not capture the reported effects of demonetisation on selected work-segments.
This leads to another puzzle. Compared to business confidence, consumer confidence has been more adversely affected. This has implications for future growth; it implies weaker consumption demand, which might make closing the capacity utilisation gap an extended exercise, further delaying the private investment cycle. The consumer-confidence drop emanates from worsening perceptions of “economic conditions”—given the current outlook, this will likely improve.
Overall, domestic and global conditions have changed for the better, but their cumulative impact on India still bears watching closely. The Monetary Policy Committee, in its policy review , kept the policy repo rate unchanged, and will, may be, continue to do so even in the near future. However, three significant developments—the sharp rise in India’s Ease of Doing Business ranking, the bank recapitalisation programme, and the improvement in sovereign credit rating—all indicate a perception of improvement in India’s structural fundamentals, and consequent of potential growth.
With contributions from