Economic Survey projects FY18 GDP growth at 6.75-7.5% post demonetisation

FY17 GDP growth reduced by 25-50 basis points due to note ban

The real GDP growth in 2017-18 is projected to be in the range of 6.75-7.5 per cent, said the Economic Survey 2016-17. The government has said that the adverse impact of demonetisation on GDP growth would be transitional. The Economic Survey, presented in Parliament by Union Finance Minister Arun Jaitley, has stated that once the cash supply is replenished, which is likely to be achieved by end-March 2017, the economy would revert to normal.

The Economic Survey pointed out that demonetisation would have both short-term costs and long-term benefits. Briefly, the costs include a contraction in cash money supply and subsequent, albeit temporary, slowdown in GDP growth. While the benefits include increased digitisation, greater tax compliance and a reduction in real estate prices, which taken together could increase long-run tax revenue collections and GDP growth.

Costs and benefits of the note ban

On the benefits side, early evidence suggests that digitisation has increased since demonetisation. On the cost side, effective cash in circulation fell sharply although by much less than commonly believed — a peak of 35 per cent in December, rather than 62 per cent in November since many of the old high denomination notes continued to be used for transactions in the weeks after November 8, 2016. Additionally, remonetisation will ensure that the cash squeeze is eliminated by April 2017. The cash squeeze in the meantime will have significant implications for GDP, reducing 2016-17 growth by 25 to 50 basis points compared to the baseline of seven per cent. Recorded GDP will understate impact on informal sector because, for example, informal manufacturing is estimated using formal sector indicators (Index of Industrial Production). These contractionary effects will dissipate by year-end when currency in circulation should once again be in line with estimated demand, which would also allow growth to converge to a trend by FY 2017-18.

The Economic Survey stated that the weighted average price of real estate in eight major cities, which was already on a declining trend, fell further after November 8, 2016, with the announcement of demonetisation. It added that an equilibrium reduction in real estate prices was desirable as it would lead to affordable housing for the middle class and facilitate labour mobility across India — currently impeded by high and unaffordable rents.

The survey also suggested a few measures to maximise the long-term benefits and minimise short-term costs. One, fast remonetisation and especially, free convertibility of cash to deposits, including through early elimination of withdrawal limits. This would reduce the GDP growth deceleration and cash hoarding. Two, continued impetus to digitisation while ensuring that this transition is gradual, inclusive, based on incentives rather than controls and appropriately balancing the costs and benefits of cash versus digitisation. Three, following up demonetisation by bringing land and real estate into the GST. Four, reducing tax rates and stamp duties. And finally, an improved tax system could promote greater income declaration and dispel fears of over-zealous tax administration.