Demonetisation impact: GDP growth may fall to three-year lows

Finance Minister Arun Jaitley has said that demonetisation will be good for India's economy in the long run. However, the short term pain must be endured and how. 

India Ratings (Ind-Ra) has also revised its gross domestic product (GDP) growth forecast for FY17 to 6.8%, 100bp lower than its earlier projection of 7.8%, reasoning the below mentioned disruptions.

Sunil Kumar Sinha, Principal Economist and Director Public Finance of India Ratings said, “Disruption has been caused at various level of economy due to de-legalisation of banknotes of Rs 500 and Rs 1000 denominations. Ind-Ra analysis shows that the economic cost of the de-legalisation will be Rs1.5 lakh crore for FY17.”

Sanjeev Prasad, Suvodeep Rakshit and Sunita Baldawa analyst of Kotak Institutional Equities in its report on November 09, said, “We see the government’s move as a positive for the economy in the medium term. The latest step appears to be the final one in the government’s systematic approach to remove black money from the economy.”

Looking at the past experiences of demonetisation, Ind-Ra said, “Global experience, including that of India in the past has shown that the impact of such measures have been fairly short-lived (India followed the de-legalisation route twice in the past, firstly in 1946 and then 1978) as it does not attack/plug the mechanism that gives rise to black income.”

Former PM Manmohan Singh in Rajya Sabha said, "Demonetisation move can hurt India's GDP by 200 basis points.”

Ind-Ra explained, “The GDP component on demand side would see worst hit in investment, particularly private investment, which is already down and out due to various reasons, will face the brunt of the de-legalisation.”

Considering the cash crunch, consumption demand has fallen impacting both wholesale and retail sales, which has reduced sales in the informal sector by 30%-40% during the first fortnight following the de-legalisation, said Ind-Ra.

Therefore, Ind-Ra expects private final consumption expenditure (PFCE) to grow at 7.5% in FY17, 89bp lower than our earlier projection.