One year of demonetisation: Strongest drivers of economy were the worst hit

Consumption and services, the strongest drivers of pre-demonetisation growth, weakened significantly after December 2016, as reflected in the steady de-growth of consumer durables until recently

The government’s move to demonetise high-value currency, announced on November 8, 2016, was meant to root out unaccounted wealth, stem terror financing and curb counterfeiting. However, it has been argued that the objectives achieved were very little when compared to the disruption witnessed by the economy in the aftermath of demonetisation. Rupa Rege Nitsure analyses the impact of the move in the one year since its implementation of the move.

This piece on demonetisation impact is likely to be criticised as the logical fallacy – Post Hoc Ergo Propter Hoc, which means “after this, therefore because of this”. This is because even before “demonetisation” was launched on November 9 last year, India was facing several macro headwinds and uncertainties (both domestic and global). 

Domestically, some risks to growth had emerged due to the lingering effect of three subdued monsoons (2013-15), continued balance-sheet stresses for large corporates and banks and the large-scale redemption of NRI deposits. Globally, developments like Brexit, monetary policy normalisation and election fever in the US had increased pressure on the rupee and rupee liquidity. Yet, there were a few bright spots. Monsoon in 2016 was near normal, investment sentiment was up marginally, though restricted to consumer goods, automobile, roads and renewables. Micro & small units from manufacturing had started doing better in terms of profitability, and services’ growth held firm in double digits for many quarters before demonetisation was effected.

And, these were precisely the sectors that suffered a direct blow from demonetisation. Activities in agriculture, rural belts and unorganised segments suffered the most due to their high dependence on cash transactions. Mandi prices of food grains, especially pulses (a proxy for farmers’ income) crashed across the nation and the downtrend continues even today. This gave rise to farmers’ protests and demand for debt waivers, with dreadful consequences for states’ fiscal positions. Already, five states – Maharashtra, UP, Punjab, Karnataka and Rajasthan – have announced loan waivers in 2017-18 and reports say a few more states are considering such loan waivers. 

Consumption and services that were the strongest drivers of pre-demonetisation growth weakened significantly after December 2016, as reflected in the steady de-growth of consumer durables until recently. Within services, trade, real estate, hotels & restaurants, construction and transport were particularly hard hit. Investment sentiment, already fragile, further deteriorated, as shown in the sustained de-growth of capital goods’ production and the collapse of average bank credit growth to commercial sector from 9.9% in January-October, 2016, to 5.6% in the period from November 2016 to September 2017. Several micro and small companies went out of business as they could not get working capital. This is amply captured in quarterly corporate earnings. Also, nearly 5 million jobs were lost after demonetisation, according to some estimates. Banks’ balance sheets (saddled with large corporate stresses) suffered additional stresses coming from retail and MSME sectors after demonetisation.

The RBI had to manage excess liquidity after demonetisation using conventional and unconventional measures which took a heavy toll on its payout to the government. While some “migration” happened from cash to digital payments in the first few months after the demonetisation move, there was a decline in electronic payments subsequently once sufficient currency was back in circulation. Empirical research shows migration from cash to digital payments is a very slow process and directly linked to the nation’s state of development. 

As stated by the government’s Economic Survey, true losses from demonetisation can never be measured accurately, as informal sectors (that witnessed de-growth) are not captured adequately in our GDP measurement.  

The author is Group Chief Economist, L&T Financial Services