Demonetisation to hamper growth in the short term with challenges in implementation

The Government of India’s recent move to demonetise old series Rs. 500 and Rs. 1,000 notes, which constituted about 86 per cent of the country’s total currency, aimed at ending the ghost economy, may actually hit the real economy in the coming months. The move is expected to have short term macroeconomic impacts of the cash crunch that include a temporary delay in consumption and investment, disrupted supply chains, farmers being unable to buy inputs, and some loss in productivity due to time lost to deal with cash issues, though there are larger implications in the medium to long term. It is likely to hamper India’s GDP growth in the short term.  The positive fallout of this could be a reduction in inflation rate in the short term due to lower consumption and lesser availability of cash with people.

The probable adverse impacts of demonetisation are as under:

1. Overall negativeimpact on disposable income along with likely disruption in the consumption patterns of the general public in short to medium term.
2. Current liquidity situation disruption affects households due to non availability of new currency and short supply of existing legal tender.
3. Commodity transactions and general cash market transactions feel an immediate impact.
4. Unorganised sectorproceedings including small trade market activities remain volatile.
5. Roadside vendors, cab drivers, kirana stores etc where business depends of 500 and 1000 notes have been severely affected.
6. Commoditiesand Agricultural sector, including the market for consumer durables and non-durables is expected to feel the heat.
7. Retail sector adversely impacted in theshort to medium term, as large denomination purchases likely be made via electronic purchases rather than through brick and mortar outlets.
8. The real estatesector is likely to see a significant negative impact in the medium to long term particularly in the repurchase market.
9. The luxury goodsmarket is also likely to get affected as this move represents an erosion of real wealth to a large number of people.
10. Areas ofsub-sectoral impact will be felt in luxury cars, SUVs, gems, jewellery, gold and high-end branded products
11. Negative GDPimpact in the current quarter as consumption gets a shock in the immediate term.
12. Loss of wealth will also be there, as some individuals and companies will choose not to deposit funds into the formal financial system to avoid disclosing their sources.
13. The informal sector could soon go back to business as usual, as there are no new incentives for people to avoid cash transactions.
14. Bank Asset quality is likely to have negative effects as demonetisation could also affect the ability of borrowers in formal sectors that rely on cash transactions to service their loans, which is why the RBI has temporarily allowed banks to give small borrowers more time to repay loans.
15. Cost of withdrawing high-denomination currency notes to wipe out black money from the country will be about Rs. 1.28 lac crore during the 50-day window till December 30, 2016, as per the estimates of the Centre for Monitoring Indian Economy (CMIE). This include, Government and the Reserve Bank of India’s estimated cost of Rs. 16,800 crore, largely on account of printing new currency notes and transporting them to banks; impact of Rs. 61,500 crore on businesses; and banks bearing a cost of Rs. 31,500 crore due to overheads and operational costs of  recalibrating ATMs to dispense new notes. Banks would do little else during this 50-day period. People standing in queues to exchange or deposit old currency notes bear 12% of the total cost and could lose Rs. 15,000 crore in foregone wages during the period. CMIE estimates the direct impact on business in terms of the drop in discretionary spending by households. This alone adds up to more than half a trillion rupees during the 50-day period till end of December. However, the impact of low liquidity, broken supply chains and loss of confidence in consumers is likely to impact the economy over a longer period, according to the CMIE.

 CMIE Estimates

  Moody’s

Few takers Vendors await customers at Meena Bazaar, in New Delhi on Friday. The macroeconomic effects of the cash crunch include a temporary delay in consumption.