Demonetisation Could Knock Off 1 Percent From GDP Growth
The decision to withdraw old Rs 500 and Rs 1,000 notes, accounting for 86 percent of the currency in circulation by value, has left the economy struggling through a cash crunch.
Estimates suggest that it will take weeks, maybe months, for the supply of cash to get normalised. In the interim, transactions across sectors could take a hit. In particular, segments like retail could see a drop in volumes as consumers hold back on purchases.
This hit to transactions, however, could normalise quickly if the supply of new currency notes picks up. A more medium-term impact could be felt in sectors like real estate where the reduction of the black money component could bring down prices. This, in turn, could benefit consumers but add to the pressure on builders.
A week after the decision was announced, economists are starting to quantify the economic impact of demonetisation.
In a report released on Thursday, Pranjul Bhandari, chief India economist at HSBC wrote that GDP growth could be lower by 0.7-1 percent over a year. Bhandari said that the hit to growth has been calculated based on two methods - the cash elasticity of GDP and consumer behavior.
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. Alternate estimates based on consumer behavior also point to a similar ballpark.Pranjul Bhandari, Chief India Economist, HSBC
Bhandari added that the growth disruption would flow through channels such as the negative wealth effect felt by those losing net worth and others who are finding it difficult to transact due to the shortage of cash.
In a conversation with BloombergQuint, Arvind Virmani, former chief economic advisor said that there will be a negative impact on sectors which depend on cash. The rural economy, where cash will take longer to reach, will also be impacted.
There will be a fairly severe effect on retail trade and retail business activity in general, including day labourers, for a week or two. After that, gradually, in the large metros, cash supply will pick up, but to reach the remotest areas it will take three to six months.Arvind Virmani, Former Chief Economic Advisor
In a separate conversation, former Chief Statistician of India Pronab Sen agreed with that view and said that his rough calculation suggests that the near-term impact could be up to 1 percent of GDP. One sector which could be impacted by the cash crunch is the informal finance system, which in turn could hit consumers and small business who depend on this network for financing.
What will happen is that it will impact the stock of currency that is lying with these institutions. The money that has been lent out is okay because it is in circulation. It’s the money that is lying in stock that will be a problem.Pronab Sen, Former Chief Statistician of India
As demand in the economy takes a knock, there will be some impact on inflation as well.
Bhandari of HSBC estimates that inflation may be lower by 20 basis points over a year. However, lower inflation may not be felt immediately due to supply disruptions. The lower inflation would allow the Reserve Bank of India to lower rates by another 25 basis points this fiscal.
Our estimate of the Phillips curve (which describes the relationship between output gap and inflation) suggests that with lower growth (of about 0.7-1.0 percentage points) and a wider output gap (of about 0.4-0.5% of GDP), inflation can, on average, be 20 basis points lower over a year.Pranjul Bhandari, Chief India Economist, HSBC