Economists see ‘Short-Term Pain, Long-Term Gain’

Economists see ‘Short-Term Pain, Long-Term Gain’

Demonetisation could help propel economic growth into double digits as more of the informal economy becomes formal.

While the government’s demonetisation drive will likely negatively impact the economy in the short term, it could help over the longer term propel economic growth into double-digit levels as more of the informal economy becomes formal and the Goods and Services Tax comes into effect, according to economists.

Another benefit from the drastic currency step could be a reduction of banks’ non-performing assets, a critical constraint that is holding up the flow of bank credit for private sector investment in the country.

“To the extent that there is shrinkage of money supply, conventional economics says that that should be deflationary,” said Ajit Ranade, Chief Economist of the Aditya Birla Group.

“It will lead to a contraction of output as well in the short run, so there will be an impact on GDP.”

“However, in the long run, say within two years, this move combined with the Goods & Services Tax legislation will help in a pick-up, and take the country’s growth to double-digit levels,” said Girish Vanvari, Partner and Head, Tax, KPMG in India.

“The NPAs of banks will go down as the cash coming in will lead to higher CASA (current account, savings account), in turn declogging the system. Foreign investors have welcomed this as a bold move, and in the right direction.”

“More savings will enter the formal financial economy,” Mr. Ranade added. “India has a fairly high savings rate, but the financial part of that is low, so that is likely to go up. Then the exponential increase in all the cashless mechanisms like cashless wallets and online banking may also help in the formal part of the economy.”

Looking a little deeper at the sectoral impact, the view is that the demonetisation move will hurt growth in cash-heavy sectors like real estate, gold and jewellery.

“Interest rates will come down because the money will go to the banks and to some extent some of it will go to the government as taxes,” Indranil Sengupta, India Chief Economist at Bank of America Merrill Lynch, said. “Also, there is going to be a short-run demand shock. But a lower interest rate will cushion this to some extent. Once the RBI’s currency liability shrinks, we think they will have lower open market operations.”

Kotak Institutional Equities was of the view that the consumption of high-value items like jewellery or real estate will get impacted as these have been popular with those having unaccounted income or wealth.

“We believe small businessmen and self-employed professionals would make attempts to become a part of the formal economy over time by reporting higher income and paying full income and indirect taxes,” Kotak Equities wrote in a report.

Rate cuts

“We believe that additional measures like monetary stimulus in the form of rate cuts and liquidity infusion in the formal system will aid the economy in handling this situation in an appropriate manner,” according to Nimesh Shah, MD and CEO, ICICI Prudential Mutual Fund.

“As consumption will be hurt, there will be pressure on the repaying capacity of producers/sellers,” Motilal Oswal Financial Services wrote in a note to clients.

According to Anand Rathi Securities, demonetisation will be a logistical nightmare in the short term leading to a slowdown in consumer spending and likely decline in GDP over the next two quarters. However, the subsequent two years would see the gross domestic product register a sharp “hockey stick” revival, the securities firm wrote in a note.

The overall economic impact would include a likely appreciation of the rupee, a sharp slowing in inflation, the banking system getting a boost and real estate prices falling about 20-25 per cent before stabilising, according to the domestic brokerage. Stocks would benefit the most due to the gradual shift from physical assets to financial assets, it added.

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