April 3, 2017    4 minute read

India’s Economic Outlook After Demonetisation Isn’t All Doom and Gloom

Five Months In    April 3, 2017    4 minute read

India’s Economic Outlook After Demonetisation Isn’t All Doom and Gloom

It has been over five months since India’s prime minister Narendra Modi’s suprise move to demonetise the 500 rupee and 1000 rupee bank notes. The intention was clear: curb the vast sums of black money in use in an attempt to control corruption, especially as India ranked 79/176 in the corruption perceptions index. This move was also at a time of increasing tension with Pakistan over cross-border terrorism, which is believed by Modi to be funded through the movement of illicit funds. In an announcement on India’s state television channel Doordarshan, Modi pleaded to the Indian general public to bear the “pain” for “50 days” to help him deliver the “India of your dreams”. Although there have been significant short-term consequences, India’s economic outlook after demonetisation isn’t all doom and gloom.

Short-term Consequences

Admittedly, removing an estimated 86% of India’s currency from circulation did have its downfalls. Initially, the limit for the exchange of the high-denomination notes was fixed at 2,000 rupees per person from the 8th to the 13th November. It was increased to 4,500 rupees per person from 14th to 17th November and later reduced to 2,000 rupees per person from 18th November, before exchange was permanently stopped on the 25th November.

Similarly, an initial limit of 10,000 rupees a day was placed on bank withdrawals and 2,000 rupees a day for ATM withdraws. Even though these limits were gradually increased, this did not prevent chaos and fear among the general public with extremely long lines outside ATMs and Banks. In particular, those living in rural areas were potentially the most hard hit considering that 18.8% of India’s ATMs are distributed in rural centres and there is estimated to only be 1 bank branch per 1000 Indians.

Economic Growth, Inflation and Government Policy

One of the main criticism of Modi’s demonetisation policy is its impact on economic growth. GDP growth rate forecasts by many institutions including Goldman Sachs, HSBC and the World Bank were lowered. Additionally, the fast-moving consumer goods sector contracted by 1-1.5% in November 2016 and year-on-year sales at Hero Motocorp, the largest seller of two-wheelers, slid by more than a third in December 2016.

However, there is good reason to be optimistic. With the key repo rate of the Reserve Bank of India held at 6.25% and the bank rate at 6.75%, the scope for expansionary monetary policy in the form of rate cuts could increase economic growth in the future. According to a Deutsche Bank report, the government is expected to increase public spending in the next fiscal year, which could reduce the initial effect that demonetisation has had on consumer demand. “This could help push up FY18 real GDP growth to about 7.5%, with the recovery likely to be more back-ended,” Deutsche Bank added.

In terms of inflation, the Consumer Price Index rate fell modestly from 3.63% in November 2016 to 3.17% in January 2017 however it has since rebounded to 3.65% in February 2017. With the Reserve Bank of India (RBI) target held at 4%, this should be the least of India’s concerns.

 

After Demonetisation: A Cashless Society?

A significant benefit after demonetisation is the movement towards a more digitised society and a reduction in the use of cash as legal tender. Following demonetisation, it is estimated that 2.5 million people in rural India have gone digital and Paytm, a mobile wallet firm, announced a record number of 7 million transactions. Although 2.5 million may seem relatively insignificant considering the country’s vast population of over 1 billion people, this is a move in the right direction and will only help to increase the transparency of payments within the economy.

Overall, the period immediately after demonetisation did see significant short-term downsides, as the move sparked fear amongst the general public and dampening consumer demand through the cash shortage. However, the government’s use of both monetary and fiscal policy in the following months will be crucial in order to regenerate economic growth and keep inflation close to the 4% RBI target. The bold move by Modi’s government must be commended, and time will tell if its effects on the fight against black money and corruption will be lasting.

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