How scary & for how long: others speak

Two clips from footage show Manmohan Singh (left) speaking and Narendra Modi listening to his predecessor in the Rajya Sabha  on Thursday. (PTI picture)

Jayanta Roy Chowdhury, TT, New Delhi, Nov. 24: Former Prime Minister Manmohan Singh believes the Modi government's demonetisation drive could shave off India's growth rate by 2 percentage points this year - a terrifying forecast which, if it materialises, could see India's growth rate sink below that of Bangladesh which has been averaging 6 per cent growth in recent years.

Singh characterised the demonetisation exercise as a monumental blunder and asserted that his dire forecast was an underestimation and not an overestimation.

The Indian economy grew by nearly 7.6 per cent in 2015-16 and by 7.1 per cent in the first quarter of the current financial year.

Other economists have been putting out less harrowing forecasts, suggesting that the country's growth rate could dip by anywhere between 40 basis points and 1 percentage point - even as they remained divided on how soon the economy could return to normality with projections varying from six months to a year.

The demonetisation drive has only exacerbated the downside risks weighing on the economy: the depressed private investment climate, subdued capacity utilisation, corporate balance sheet de-leveraging, depressed global output and weak exports.

"We expect the impact on economic activity will probably continue for the next two quarters," said Govinda Rao M., former member of the Prime Minister's Economic Council. "The immediate impact has been to compress demand due to the cash shortage. Some 80 per cent of the economy runs on cash... the impact on farming, trade, services and industry, especially small scale industry is severe."

The country's informal economy, which accounts for 45 per cent of the GDP of $2.1 trillion, is facing an acute cash crunch and is in danger of caving in.

A knock-on effect is also being felt by the organised manufacturing and services sectors that are dependent on demand generated by the informal economy and rely on supplies and logistic support provided by that sector.

"Although it's a bit early to make a precise forecast, I surmise the GDP growth could take a hit by 40 basis points and that is without taking into account the damage to industrial production," said Pronab Sen, former chairman of the National Statistical Commission. "The huge cash vacuum combined with the stringent cash withdrawal limits is also choking production transactions, besides hitting the large informal sector."

The demonetisation move has turned into junk currency worth Rs 13.7 lakh crore, which makes up 86 per cent of India's currency in circulation. "The overall impact of the move will be spread over both this quarter as well as the fourth and last quarter of this financial year," said Sen.

Agreed Rao. "The adverse effect will be greatest on the informal sector, which means poor people and less developed regions will suffer more."

The trading and informal sectors have already taken a hit after the decision to scrap high-value notes. Empirical evidence suggests that demand has halved in many sectors. However, more alarming is that production relations have been hit because of the cash crunch, said Sen.

Truckers have reported a 40 per cent drop in rentals, which suggests that both demand and supply constraints are hitting the economy.

Empty shelves at retail stores are in part explained by lower demand and lower ability of traders to buy replacements, but also in large part by logistical constraints. Business chambers ominously report that firms have temporarily shut down production lines.

Sen believes one sector - the informal financial sector of hundis, nidhis and chit funds which accounts for 40 per cent of formal bank lending which is worth about Rs 74 lakh crore - has been delivered a crippling blow as a result of the demonetisation.

"Some of the cash swilling around in that segment was indeed black money. It did occupy an important part in trading, agricultural and production relations. It will continue, but with significant impairment."

N.R. Bhanumurthy, of the government think tank National Institute of Public Finance and Policy (NIPFP), feels the impact could be even greater, a view shared by many who are sceptical about the benefits that the government believes will flow from the demonetisation drive.

"As the demonetisation would reduce the money supply due to incomplete replacement in the system, this is expected to reduce the GDP growth not only in the shock year but also in the T+1 period," Bhanumurthy added.

Bhanumurthy, however, added that his worst-case scenario could improve "as some of the currency, which was not part of the financial system earlier, comes back to the banking system and there are policies to increase cashless transaction.... This could have a positive impact on growth compared with the base case."

"The success of this demonetisation policy (on growth) depends heavily on the speed and smoothness at which the existing currency in circulation is replaced with new currency," the NIPFP economist noted.

The total value of the new notes printed till now is about Rs 120,000 crore, according to official sources. The finance ministry has ordered all four of its currency printing presses to work three shifts instead of the usual one or two shifts to try and print replacement currencies in the new Rs 500 and Rs 2,000 denominations as well as older Rs 100, Rs 50 and Rs 10 notes.

However, this "rush through printline" programme will still take weeks, if not months, for India to be able to fully replace the money that has virtually gone up in smoke. "One cannot expect 100 per cent replacement... but I feel that it will take till end-December for the cash withdrawal impact on the poor to be mitigated," Rao said.

North Block mandarins have repeatedly said "there is enough cash" and finance minister Arun Jaitley has advised patience to tide over the "period of inconvenience". But the fact remains that as of date some 90 per cent of the cash sucked out has not been replaced and this represents about 75 per cent of the total cash in circulation. "This means that our cash-dependent economy is struggling to create new transactional relationships to replace King Cash," said Sen.

Many analysts feel the policy was hurried through and not thought through.

"We have no experience of demonetisation on this scale... hence accounting for the time needed to mitigate its effects is something that we are still in the process of learning," said Sen.