India Ratings lowers GDP forecast to 6.8% post demonetisation

Govt has claims root out black money, is likely to destroy Rs 4.004 trillion worth of cash held in black money and fake currencies

India Ratings on Friday lowered its GDP forecast for 2016-17 to 6.8% from 7.8% earlier, stating that the demonetisation drive will lead to an erosion of Rs 1.5 trillion this financial year.

"We have revised GDP growth forecast for 2016-17 to 6.8%, 100 basis points lower than earlier projection of 7.8%. The downward revision is a fallout of the disruptions caused at various levels in the economy due to the de-legalisation of banknotes from November 9, which according to our analysis can cost economy a Rs 1.5 trillion," it said.

It said the measure, which the government claims root out black money, is likely to destroy Rs 4.004 trillion worth of cash held in black money and fake currencies.

"This constitutes a mere 12% of the black economy, leaving 88% of black money to remain in the system. Global experience has shown that the impact of such measures have been fairly short-lived as it does not attack or plug the mechanism that gives rise to black income," the report said.

The nation has tested demonetisation twice in the past, first in 1946 and then in 1978.

It pointed out that the investment will be worst affected due to the demonetisation.

"Investment, particularly private investment, which is already down and out due to various reasons, will face the brunt of the de-legalisation. We now expect gross fixed capital formation for this year to grow at 2%, down 306 bps from our earlier projection," the agency said.

With the decline in cash holdings in the hands of the public and severe restriction in the flow of new cash, consumption demand has also fallen impacting both wholesale and retail sales, it observed.

"Anecdotal evidence suggests that cash squeeze has reduced sales in informal sector by 30-40% during the first fortnight following demonetisation. Therefore, we expect private final consumption expenditure to grow at 7.5% this year, 89 bps lower than our earlier projection," it said.

The report, however, noted that demonetisation and the government efforts to promote the digital platform for transactions will gradually increase the share of the formal sector and expand the tax base of the economy in the medium-to long-term.

Also, as transactions through the digital platform increase, it will create financial and transactional history of the informal or cash dependent segment, making them bankable over the medium-to long-term, it added.