 "ATM, banks, cash, currency, rupee, demonetisation, line, withdraw, money")
December 30th marks the end of the NDA government’s most ambitious policy to date that demonetised roughly 86 per cent of the country’s currency in circulation, the largest such exercise in the world.
After more than 60 notifications, some of them reversing previous announcements, and a second income disclosure scheme, the government will now finally have a clear sense of much of the old currency has been deposited into the system and the fiscal bonanza it may have reaped.
While the Prime Minister had sought 50 days from the public to deal with the pain of demonetisation, the hardship is likely to continue as the pace of remonetisation has been slower than expected. Across the country, bank branches are still unable to dispense the entire Rs 24,000 limit. Many ATMs are still not dispensing cash. SBI Chairperson Arundhati Bhattacharya has also indicated that restriction on withdrawals cannot be lifted entirely unless more cash is made available to banks.
While it’s early to gauge its impact on the black economy and economic growth, opinion remains sharply divided. While some economists expect the hardship to last only two quarters, others predict sustained hardship.
Prior to November 8th, the consensus among economists was that the third quarter would mark the beginning of a consumption led recovery. But demonetisation has dealt a strong blow those hopes.
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With cash – the primary medium of exchange - all but disappearing, it is now unlikely that the expected fillip to demand on account of a good monsoon and proceeds from the 7th pay commission payout will materialise. With a revival in the investment cycle nowhere in sight, and export growth continuing to be sluggish, growth is now on an even weaker footing than before.
The worry now is that with aggregate demand collapsing, firms will cut back on production as inventories pile up. Smaller ones will struggle. Some may resort to firing workers, depressing consumption further. This will also delay fresh investments. A vicious cycle will ensue. Or so it is feared.
Given the unprecedented nature of the move, it is difficult to accurately gauge the impact of demonetisation on growth. RBI believes it will affect growth only to the extent of 15 basis points. But with private forecasters paring their growth estimates by a greater magnitude, RBI’s projection spurs a certain amount of scepticism.
If leading economic indicators are any indication, growth is likely to slow down sharply. Sales of two wheelers a leading indicator of rural demand contracted 5.2 per cent in November, while those of Light and medium and heavy commercial vehicles declined by 9.3 per cent and 4.2 per cent respectively. Nomura’s composite index is at its 1996 low which is consistent with 6 per cent growth. The sings are ominous. It would seem that the RBI is too worried about inflation, while being too complacent on the growth front. But with many economists questioning the efficacy of monetary and fiscal policy to offset the disruption in economic activity caused by demonetisation, concerns that the effects may spill over to the next financial year seem valid.
With a demand shock of this magnitude, corporate top line growth will come under pressure. As Dhananjay Sinha, head–institutional equity, Emkay Global Financial Services, points out – the demonetisation shock is expected to nip the minor recovery seen recently, as it will have a significant impact on demand, corporate performance and the labour market.
Add to that rising input costs and corporate profitability will also come under pressure. According to a report from Kotak Institutional Equities, prices of 65 per cent of the 40 basic raw materials they track are increasing. In some cases, the increase is in double digits. This compression in margins will also impair firms ability to service their interest obligations.
Brokerage houses have already slashed their earnings growth estimates. The consensus earnings per share (EPS) estimates for Nifty companies have been cut by three per cent for 2016-17 since demonetisation according to data compiled by Bloomberg.
The carnage on the stock market provides a clear indication of the extent of pain. Post November 8th, the BSE realty index has plummeted 16.8 per cent. The consumer durables segment has fallen by 13 per cent. FMCG is down 7.2 per cent, while auto has declined by 9.7 per cent. The capital goods index is also down 6.6 per cent, reflecting the scepticism over an investment revival.
Banks are also in a precarious position. Post demonetisation, while there has been a surge in bank deposits, credit offtake has plummeted. With the gap between the two widening, bank profitability will take a hit. Add to that the possibility of firm failures which will increase loan defaults and the NPA situation could take a turn for the worse. Fearing a rise in loan defaults, RBI has extended the repayment of loans by an additional 30 days. Earlier, it had postponed the payment window by 60 days.
Yet demonetisation continues to find popular support. People do seem to be appreciating the move to cleanse black money from the system, discounting their temporary hardship.
Politically though it’s difficult to know for sure how things play out. While the move has ended up hurting the interests of the BJP-RSS’s traditional support base of traders and small entrepreneurs, the Prime Minister continues to enjoy an enviable degree of popularity.
But it’s difficult to know for sure which way the wind is blowing. Perhaps the upcoming UP elections will offer an indication.
