100 Days After Note Ban: Economic Indicators Blinking Yellow

Economists estimate that about 70 percent of the currency will be replenished by March.

Prime Minister Modi announced demonetisation on 8 November. (Photo: Reuters)

Its been 100 days since the Narendra Modi-led government announced its decision to withdraw notes of Rs 500 and Rs 1000. The move was hailed as a bold attempt to formalise the economy by the government and its supporters. Detractors, in turn, termed it as foolhardy and said it will achieve little except damaging a slowing economy.

While opinions on both sides are definitive, the data is anything but. Most banking and economic indicators are stuck in no-man’s land. They have rebounded from depths seen in December when the currency crunch was at its worst, but are still to return to levels seen before demonetisation.

What Will The New Normal Settle At?

India has been largely a cash driven economy and taking away cash meant that economic activity would be impacted. The official stance was that this would be transitory, but professional forecasters have predicted a sharp fall in GDP growth to near about 6.5 percent in fiscal 2017 versus 7.9 in fiscal 2016.

Most expect growth to rebound in fiscal 2018. The Reserve Bank of India is forecasting next’s year growth at 7.4 percent compared to a forecast of 6.9 percent this year.

High frequency indicators are moving in tandem with that theory so far.

The Nikkei Purchasing Managers’ Index (PMI) for manufacturing fell to 49.6 in December, for the first time in 11 months. But it moved back into expansion territory in January with the index at 50.4. The question now is where the index will stabilize and whether it will rebound to pre-demonetisation levels when the manufacturing PMI was at a 22-month high of 54.4 (October 2016).

The Index For Industrial Production held up in November but showed a decline in December with growth contracting by 0.4 percent. If the IIP follows the manufacturing PMI, a rebound is likely in January.

Some indication of a demand hit can also be gleaned from the consumer price inflation data, where ‘core core’ inflation reflects subdued conditions. Core inflation strips out volatile food and fuel items. If you further strip out items like transportation, gold and silver, you get ‘core core’ inflation. This sub-segment has been falling, reflecting slowing demand.

The systematic decline in average core-core inflation to 4.85 percent year-on-year in FY17 (April-December) from 5.38 percent over same period in FY16 – a correction of 50 bps indicates continued demand compression in the economy, despite government imposing two rounds of cess on taxable services over FY16 and FY17. The compression is likely to have got further intensified in the post demonetization months, the impact of which should continue to be felt in the ongoing quarter.

Yes Bank research Report (Feb 13th)

On the supply side, whether demonetisation impacted supply chains, particularly in the informal sector, remains unclear. There is no official data source which would give a clear picture of the disruption, if any, in the informal sector.

It is equally tough to judge whether demonetisation is having the intended impact of pushing a larger part of the economy into the formal sector. That may take years, said independent analyst V. Anantha Nageswaran in an interview with BloombergQuint earlier this week.

I think I would look at the proportion of organised versus unorganised employment in the country going forward. I would also look at the number of income tax assesses who will come into the tax net and the proportion of direct tax collections. These are at least two of the metrics. Also, maybe the potential GDP growth rising and whether we can have a longish stint of sustainable and high growth without triggering inflation.... The problem is that this will take a few more years to judge and by then people will not even associate it with demonetisation.

V. Anantha Nageswaran, Independent Analyst

Source: Government data

Has The Negative Wealth Effect Been Ruled Out?

The second fear following the announcement of demonetisation was that if a significant portion of the old cash gets extinguished, there will be a negative wealth effect to deal with. As it became clear that a large part of the currency had been deposited into bank accounts, these fears eased and most economists ruled out a significant negative wealth effect from demonetisation. The fact that stock markets also recovered quickly from the shock was also comforting.

However, the real estate market, where a lot of Indian wealth is locked, is currently in limbo with no clear data suggesting a rebound.

On Wednesday, DLF Ltd, the country’s largest listed real estate developer reported earnings for the December quarter. It reported a 29 percent fall in sales compared to the previous year. Equally worrying was that cancellations stood at nearly 50 percent of gross sales in the first nine months.

DLF is reflective of the broader real estate market. Knight Frank pegs the fourth quarter of 2016 as the worst three months for real estate in six years. Sales fell 44 percent and new launches plunged 61 percent during the quarter.

Source: Government Data

If the stagnation in the sector leads to significant price falls (which have not been seen yet), developers will feel the heat, but so will consumers who used real estate as an investment option.

To be sure, a fall in prices may also spur fresh demand, particularly in the residential real estate segment, but that will only happen once the prevailing deadlock between buyers and sellers breaks.

Will Cash Be King Again?

On March 13, 2017, all cash withdrawal limits will be lifted. This suggests that there will be adequate amounts of new currency in the system in about a month from now. The question is what ‘adequate’ refers to and whether currency in circulation will return to levels seen before demonetisation.

According to the latest data released by the Reserve Bank of India on Wednesday, currency in circulation was at Rs 10.97 lakh crore as of February 10. This is about 61 percent of the Rs 17.97 lakh crore in currency in circulation at the time of demonetisation. By March, economists estimate that about 70 percent of the currency will be replenished.

As cash has returned, the surge in digital transactions has slowed.

According to RBI data, the value of digital transactions declined from Rs 105.4 lakh crore in December to Rs 98 lakh crore in January. Volume and value of transactions, however, remain above pre-demonetisation levels, said Arundhati Bhattacharya, chairman of State Bank of India at a press conference on Thursday.

Deposits in the banking sector also remain at levels well above pre-demonetisation. At Rs 105 lakh crore, deposits in the banking system are about 13 percent higher than last year. What proportion of these deposits continue to stay in bank accounts will only become clear after all withdrawal restrictions are removed.

Source Government Data