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The Impact, A Year Down

A question that one can pose is: at the policy level will we do it again?

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Taking the liberty of poetic imagery, demonetisation could be likened to an economic tsunami unleashed consciously to strengthen the moral fabric of society. A year down the line, the proverbial dust has settled and it appears to be business as usual with a successive disruption, the GST, diverting attention as well as severing the link between the shock and the impact. It is not surprising that the economy is linked more with the GST today.

The economic impact of demonetisation has been mixed. First, GDP growth rate has received a setback. The economy seemed to be doing very well with a good monsoon and growing consumer demand till October. When all conditions seemed fit for faster growth, GDP slowed down to 7.1 per cent from 8 per cent in FY16 and hence it would not be incorrect to say that the economy lost at least one per cent growth momentum.  

Second, employment has taken a hit especially at the unorganised level as the SME segment faced widespread disruption as its dealings were in cash. A consequence was layoffs as labour migrated back to rural India. A double whammy has now come from GST for this segment.

Third, all industries related with consumer dealings were affected in three quarters, starting Q3 FY17 to Q1 FY18. The results of companies in consumer durables, automobiles, FMCG, and housing were all impacted due to a decline in demand as cash was not available. It does seem, however, that the worst is over and the Q2 results would be indicative of the extent of recovery.

Fourth, the banking system has been in considerable disarray on account of demonetisation and is yet to recover fully, given the multiple disruptions. Two months were spent in just managing notes which came in the way of regular banking business. This was followed by a surfeit of deposits which had to be countered by the MSS facility and later the reverse repo auctions to absorb liquidity so that banks did not lose money as there was limited demand for credit. It would be interesting to see if the RBI can get the banks to declare the fresh NPAs which emanated especially from the SME sector during this period. Ironically, the surplus deposits which flowed to the banking system helped to push up GDP growth as the methodology includes overall banking business defined as sum of credit and deposits which increased during this time.  

Fifth, the RBI has been able to restore normalcy by March 2017. But the cost has been high which can be measured broadly by the fall in the surplus generated on its income and expenditure account which is lower by around Rs 30,000-35,000 crore. This would not affect the RBI as such, but the government, as the transfer has been lower.  

Sixth, the government could be satisfied that the scheme went through peacefully with a majority support.  The number of tax payers has increased sharply and one may expect the government to reveal the amount of black money that was unearthed through the income tax summons or on the amnesty schemes offered. Also the higher flow of direct taxes will be of importance as the same was to lead to two important policies: first the possibility of reducing direct tax rates and second, transferring funds to the poor on account of black money being brought out.

It would be hard to draw up a balance sheet enumerating the gains and losses from demonetisation. A positive fall out has been the development of the digital economy which would have otherwise taken time to evolve. While there can be no clear judgment passed, a question that one can pose is: At the policy level will we do it again?

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

Madan Sabnavis

Sabnavis is chief economist, CARE Ratinigs and author, more recently of Economics of India: How to Fool all People for all Times

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