Demonetisation deals body blows to economy

It was on November 8, 2016 when a total of Rs 14.5 lakh crore (86% of currency in circulation) was snuffed out of the system in the country putting the common man in distress and the economy dented as the BJP-ruled Centre demonetised Rs 500 and Rs 1000 currency notes.

Though the intent of Prime Minister Narendra Modi to eliminate the menace of black money, counterfeit notes, terrorist funding may be noble, the timing, judgement and the outcome has gone terribly wrong.

With Rs 13 lakh crore of the outlawed currency coming back into the banks before the deadline of December 30, 2016 and with the special RBI ‘window’ still open up to March 2017, the whole surgical exercise seems to be remedy worse than the  malady. Sensing the outcome, the narratives of the prime minister from November 8, 2016 till date has transformed and mellowed from ‘war on black money’ to evolution to a cashless digital economy.

The whole exercise has exposed the government on the lack of understanding of the components of black money and Reserve Bank of India’s unpreparedness to quickly remonetise   resulting in putting the economy out of gear. The anaemic remonetisation of new notes of Rs 500 and  Rs 2000 is evident with just Rs 9 lakh crore of currency in circulation as at January 6, 2017. The liquidity crunch has shattered the cash driven sectors - real estate, garments, automobile, fast moving consumer goods, jewellery, transportation, cement, fertiliser and seeds.

The factory output for November measured in terms of Index of Industrial Production (IIP) has surprisingly grown by 5.7% on account of "base effect" of contraction of 3.4 % during November. However, the IIP is flat at 0.4 % April - November as against 3.8% previous year. December growth figures will pan out the real position.

The GDP growth is expected to slip to a three-year low of 7.1% in 2016-17 as per the Central Statistical Office (CSO). We will be in reverse gear and recouping the lost glory will be painful and tedious. Moreover, the CSO estimate has not taken into account the impact of demonetisation and hence can drag the GDP by an additional 1%, which will be a huge setback to our $2.2 trillion economy.

The World Bank has cut India’s GDP forecast to 7% for 2016-17. International rating agencies also have downsized our GDP between 6.5-6.8% solely on account of the fallout effects of demonetisation, slow pace of remonetisation. It was not connected to the global uncertainties. The manufacturing Purchasers Managers’ Index (PMI) has contracted in December  - the first shrinkage in 2016. The composite PMI output index which tracks both manufacturing and services sectors was at 49.1 in November and further slipped to 47.6 in December. Above 50 mark depicts growth and below, a contraction.

Agriculture has grown at 4.1% on account of good monsoon. But the irony is  that the farmers have been seriously impacted by the ‘note bandi’. The liquidity crunch has had double whammy effect - on selling of harvested kharif crop and on sowing of rabi crops, where the entire dynamics works on ‘cash and carry’.

Real estate, notoriously branded as the epicentre of black money, has been severely affected. Sale of flats in eight major cities during October-December 2016  has sharply fallen by 44% on account of transaction freeze with huge revenue loss to the state exchequers by way of stamp duty and registration fees. New project launches have been deferred. Progress of under construction projects has slowed down. Inventory of unsold flats has risen to more than eight lakh flats PAN India on account of ‘wait and watch approach’ by prospective buyers, who are expecting huge price corrections, which will not happen more than 10%.

Job and revenue losses are to the tune of 35% and 50%  since demonetisation in the micro, small industries segment as per the survey by the All India Manufacturers’ Organisation. The projected revenue and employment loss is humongous 55% and 60% by March 2017.

Deployment avenues

For banks, it’s poverty in midst of plenty. Banks are flooded with demonetised cash without having productive deployment avenues. The credit off take is at its historic low at 5%. Rate cut race has commenced.

The SBI has led the pack of public sector banks followed by private banks and housing finance companies who have all slashed their MCLR (marginal cost of funds based lending rate) in the range of 50-90 bps (wh­ich they never demonstrated under Raghuram Rajan’s regime) thus making housing loans cheaper, as low as 8.25%-8.75%.

With Modi’s new year gift of interest subsidy of 4% and 3% for housing loans up to Rs 9 lakh and Rs 12 lakh under the PMAY (Prime Minister’s Awas Yojana) schemes, the effective interest rates to fresh borrowers will drop further and existing clients at high interest rates will "switch over" to banks which are offering least rates.

In the euphoria to aggressively lend, banks are losing sight of the tenure durability of the ‘tsunami of deposits’, its terrible impact on the interest rates leading to huge asset liability mismatch. Most deposits will be taken back once the embargo on the withdrawal limits is lifted.

Reducing the interest rates on loans to abysmally low levels even  before gauging the deposit withdrawal scenario is putting the cart before the horse. The banks which are already bleeding with NPAs of more than Rs 9 lakh crore, lack of capital, higher provisioning for bad debts will eventually incur huge losses by March 2017.

The NRIs and foreign institutional investors are not far behind. The NRIs have pulled out Rs 1 lakh crore during October and November. The FIIs, who are fair weather friends, have sucked out nearly Rs 35,000 crore from equities, adding  pressure on the rupee which can even breached Rs 70 per dollar.

In sum, the economy has taken serious body blows raising the moot question whether such a draconian and sudden demonetisation action was required to attack the 'black money’ component of 5-6% of our GDP with all the collateral damages to score political mileage at the cost of economic peril.

(The writer is a Bengaluru-based economist and banker)

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