Covid-19 Impact: Like Demonetisation, But Much Bigger

HSBC notes parallels between Covid-19 economic shock and the unprecedented cash ban of 2016.

A cow on the street in India during Covid-19 lockdown. (Photographer: Prashanth Vishwanathan/Bloomberg)
A cow on the street in India during Covid-19 lockdown. (Photographer: Prashanth Vishwanathan/Bloomberg)

As the world struggles to figure out the economic impact of the Covid-19 pandemic, HSBC economists say India can look for clues in the fallout of another unprecedented event that shocked its economy—demonetisation.

“We learnt three important lessons from the demonetisation period, which weren't obvious at first, but became clear in hindsight, with careful analysis,” wrote HSBC economists Pranjul Bhandari and Aayushi Chaudhary in their latest report. Low wages, a reversal of the “forced formalisation” of the economy and the gross domestic product data being unable to capture the ground realities were themes noted after the cash ban.

“We believe these could play out during the pandemic period as well, although on a larger scale,” they wrote. “Understanding them could help avoid pitfalls.”

Prime Minister Narendra Modi had outlawed 86% of the currency overnight more than three years ago with a short notice of barely four hours. The immediate panic aside, the note ban is estimated to have eventually shaved off 2 percentage points of GDP growth. Loan growth fell, company earnings were hit, unemployment rose to a 45-year high and chunks of the informal economy were left without cash for daily operations.

There are parallels to be drawn between that and the near three-month nationwide lockdown which the Indian economy is still emerging from. Activities came to a grinding halt as the movement of people was restricted and factories and offices were shut. Economists are now anticipating a sharp downturn in the country’s GDP, with some even expecting it to contract by double digits.

As such, the economic consequence of Covid-19 is likely to be of a larger and grimmer proportion than demonetisation.
HSBC India

Jobs Will Be Back, But At Lower Wages

Unemployment didn’t immediately spike after demonetisation. It continued to grow at 3.5% till mid-2017, lower than the 7.5% seen a year before. However, the growth was driven by a rise in rural employment with India’s heartland creating double the jobs as cities.

But despite the rise in jobs, wages continued to slide. People unable to get jobs in cities may have found work in rural India where wages were 2.5 times lower, exacerbating the country’s already lopsided labour market, HSBC said.

This seems to be repeating itself. An improvement in labour markets was seen between April and mid-June driven by a rise in rural jobs. Rural jobs have grown at more than double the urban pace, HSBC said.

The pandemic could leave India in a “low growth, low wage equilibrium”, the report said.

Covid-19 Impact: Like Demonetisation, But Much Bigger

Formalisation Could Reverse

During demonetisation, the India’s unorganised sector—that employs majority of its workforce—was hit much more due to its dependence on cash flows and lack of large buffers to absorb economic shocks.

The formal sector started taking up more share of the consumption demand as the informal sector was struggling to survive. “This episode may play out again over the Covid-19 period. We are already seeing anecdotal evidence of large companies gaining market share in select sectors.”

But HSBC cautioned that this trend of formalisation is not lasting. By 2017-18, the uptick in corporate sales began to normalise to pre-demonetisation levels.

Covid-19 Impact: Like Demonetisation, But Much Bigger

Overstated GDP

HSBC said in the first estimate by the government, the informal sector GDP is proxied with the formal sector’s. That’s fine on normal days but not when the two sectors are diverging, as is the case now, it said.

After demonetisation, GDP growth remained “surprisingly high” and was even revised upwards later. However, the weaker informal sector continued to be proxied, “arguably overstating the GDP growth”, HSBC said. “As such the GDP numbers since demonetisation do not capture the true state of the informal economy.”

With the lack of an informal sector survey, HSBC predicts upcoming GDP releases will fail to capture the true picture. “Policymakers need to have a better way to capture informal sector growth, perhaps with an annual informal sector survey.”

Covid-19 Impact: Like Demonetisation, But Much Bigger
India's Banks Play a Risky Game as Loan Truce Ends