It has been an unusual month for the world’s fastest-growing large economy.
After expanding at a rate of over 7% through the past year, India has suddenly found itself in a quagmire, thanks to Narendra Modi’s move to demonetise the country’s high-value currencies. On Nov. 08, the Indian prime minister made the Rs500 and Rs1,000 notes—which accounted for 86% of currency in circulation—invalid.
The impact on India’s growth story was rather immediate.
Goldman Sachs slashed its forecast for India’s GDP growth to 6.8% for the current fiscal. Mumbai-based Ambit Capital was even more pessimistic, forecasting that India’s GDP would grow only by a meagre 3.5% in the current fiscal. Deutsche Bank, too, cut its GDP growth forecast for India by 100 basis points to 6.5% in the current fiscal.
“We expect growth to be impacted adversely in the present and next quarters due to the government’s temporary demonetisation initiative,” Deutsche Bank said in a note. The German lender believes that India’s GDP will eventually recover next year, to grow at 7.5%.
With estimates pegging the economic cost of the entire demonetisation exercise at Rs1.5 lakh crore, Quartz takes a look at the impact of the move on various sectors of the Indian economy.
Since storming to power in 2014, Modi has tried hard to revive India’s struggling manufacturing sector, which accounted for about 16% (pdf) of the GDP in 2015. Modi wants to increase this to about 25% by 2025, but demonetisation may have thrown the sector into a tailspin.
In November, India’s Purchasing Managers’ Index (PMI)—an economic indicator of the manufacturing sector that tracks new orders, inventory levels, production, supplier deliveries, and the employment environment—stood at 52.3. That’s two points lower than the 22-month high of 54.4 recorded in October. A PMI of less than 50 indicates a contraction in the economy.
“PMI data for November showed that the sudden withdrawal of high-value banknotes in India caused problems for manufacturers, as a cash shortage hampered growth of new work, buying activity and production,” said Pollyanna De Lima, an economist at IHS Markit, one of the compilers of the index.
Experts now believe that the impact of demonetisation on the manufacturing sector will continue through December, too.
“In our view, the November PMI data may understate the near-term disruption in activity. Sales have been hit hard, which will result in higher inventory (which, surprisingly, the PMI data do not show) and result in sharper production cuts in the months ahead. Thus, we expect the PMI to drop further in December,” brokerage firm Nomura said in a report.
Despite the disruption, IHS Markit believes Indian manufacturing has done better than what many expected.
“…Whereas some may have anticipated an outright downturn, the sector held its ground and remained in expansion mode,” Lima said.
Perhaps the worst hit by Modi’s demonetisation move has been India’s services sector.
The sector comprises areas such as trade, hotels and restaurants, transport, communication, finance, insurance, and real estate, among others, and accounts for 60% of India’s $2 trillion GDP.
The Nikkei/Markit Services Purchasing Managers’ Index—which measures sales, employment, inventories, and prices at service sector companies—sank to 46.7 in November, from 54.5 in October. This is the first time since June 2015 that the index has slipped below the 50 mark.
“New business declined for the first time since June 2015, leading to a solid reduction in activity,” IHS Markit, the compiler of the index, said. “Correspondingly, backlogs of work rose, while employment increased only marginally.” The decline of 7.8 points was also the biggest one-month drop since November 2008.
Yet, IHS believes that the sector will rebound quickly.
“The disruption is expected to be short-lived, however, with many panelists anticipating a pick-up in activity as these high-value banknotes are replaced and black-market firms end their operations,” Lima said. “In fact, business confidence improved to a three-month high.”
Asia’s third-largest economy has also been hit by poor consumer spending since demonetisation. Private consumption expenditure contributes to around 60% of India’s GDP.
“Interestingly, the consumer goods sector, which has reported solid growth so far, was the weakest performer this month. This suggests that consumption—the sole growth driver—has been hit rather sharply,” Nomura said.
India’s rural economy—which services 68% of the population and has seen sluggish demand for the past two years—could take months before it sees a recovery. This rural economy was the driver of India’s consumption boom between 2007 and 2012.
“The sluggish rural consumption is staring at a further dip due to their higher dependency on cash transactions,” market research firm Nielsen said in a report on Nov.15 (pdf). “Discretionary spends will see a bigger impact in this geography. Mandis may experience a shortfall of cash for the purchase of daily essentials including fruits and vegetables; leading to further problems for farmers and having a domino effect on their ability to purchase.”
And it could take at least a few months before consumer spending is finally back on track.
“Consumer spending in at least the next two quarters will take a hit and could even cost India its designation as the fastest-growing major economy, even if the exact scale of economic disruption remains unclear,” Jan Zalewski, senior risk analyst at UK-based Verisk Maplecroft, said.
But that could also mean that India’s central bank could bring down key lending rates, since inflation has eased. A poll by Reuters on Dec.05 predicted a 25 basis point reduction in repo rates—the rates at which the Reserve Bank of India (RBI) lends to banks.
India’s agriculture sector was widely expected to have a robust year.
The rainfall was good after two years of drought and the sector was pegged to grow by about 4% in the current fiscal. The agriculture sector constitutes about 15% of India’s GDP but grew by a paltry 0.2% and 1.2% in 2014 and 2015, respectively.
Demonetisation means that the sector could once again take a hit. Agriculture is a cash-rich sector and most of the payments for the purchase of seeds, fertilizers, and tools, as well as for labourer salaries, are carried out in cash. It also doesn’t help that the sale, transport and distribution of agricultural products take place at mandis which are almost entirely dependent on cash. In addition, the RBI has also banned the exchange of old notes at co-operative banks, which farmers visit more often.
India is currently in the midst of harvesting its Kharif (or monsoon) crops and is soon expected to prepare land for the Rabi crops, which are harvested during spring.
“The agriculture sector will bear the brunt of demonetisation,” Dharmakirti Joshi, chief economist at credit rating agency Crisil said. “Farmers are finding it tough to sell their produce in the APMC (agricultural produce marketing committee) markets. Therefore, despite a good harvest, there is unlikely to be a commensurate improvement in rural demand.”
Meanwhile, investors have also been jittery since the news of demonetisation and that hasn’t helped Modi’s cause.
Since Nov. 08, the Sensex has fallen by around 5% while foreign portfolio investors (FPIs) withdrew some Rs37,300 crore in November, the highest since June 2013. FPIs had withdrawn Rs12,140 crore in October.
“Foreign investors have pulled out funds from capital markets due to fears of (a) rate hike by the US Federal Reserve in December, uncertainty over US ties with emerging markets post (the) Donald Trump victory, and concerns over the the impact of demonetisation and GST on economic growth & corporate earnings,” the Centre for Monitoring Indian Economy (CMIE), a think tank which tracks business and economic data, said on Dec. 02.
But not all is lost for the Modi government.
Despite the imminent slowdown across sectors and the hit to the Indian economy, experts also see an eventual recovery over the next year. ”Perhaps paradoxically, the temporary socio-economic dislocation is a necessary step in India’s drive towards strengthening its formal economy,” Zalewski of Verisk Maplecroft said.
With a potentially strengthened formal economy, forecasters now see India’s GDP returning to the over 7% growth phase by next year. Much of that will be due to a significant uptick in private consumption expenditure as the RBI is likely to cut interest rates.
“This could help push up the 2018 fiscal year real GDP growth to about 7.5%, with the recovery likely to be more back-ended,” Deutsche Bank said in a note.