Demonetisation has led to economic slowdown

RBI revises GVA growth rate from 7.6 per cent to 7.1 per cent for 2016-17

Parsa Venkateshwar Rao Jr

There was expectation that the interest rates would come down as a result of demonetisation. The Narendra Modi government believed in it, and it hoped that it could tout fall in rates as positive fallout of the demonetisation decision.

But the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) in its fifth bi-monthly meeting on December 7 decided to keep the lending rates unchanged.

Due to demonetization, which is described in the bank parlance as “withdrawal of SBNs (Specified Bank Notes)”, the currency in circulation plunged by Rs 7.46 trillion till December 2, and this has resulted in a surge in bank deposits and “the MPC in its statement noted that from a state of surplus money in circulation in October, it has moved to massive increase in excess reserves”. The RBI managed the excessive liquidity by absorbing Rs 5.2 trillion through reverse repo auctions that is through an indirect transfer of money from the retail banks to the central bank.

The ‘downside risks’ of demonetisation have been clearly spelled out. First, there would be “short-run disruptions in economic activity in cash-intensive sectors such as retail trade, hotels & restaurants and transportation, and in the unorganized sector.” But it is felt that the liquidity crunch would go away with the increase in currency circulation.

About the outlook for the year, the MPC says, “In October 2016, GVA (Gross Value Added) growth in H2 was projected at 7.7 percent and for the full year at 7.6 percent. Incorporating the expected loss of growth momentum in Q3 and waning effects in Q4 alongside the boost to consumption demand from higher agricultural output and the implementation of the 7th CPC award, GVA growth for 2016-17 is revised down from 7.6 percent to 7.1 percent, with evenly balanced risks.”

This would mean that the much simpler GDP growth rate figure could be less than seven per cent. The GVA includes all spending and transactions within the economy and not just the final output in the different sectors. That is why the GVA figure is usually higher than the GDP. If the GVA figure goes down, the fall in the GDP figure would be much greater.

The MPC, however, sounds tentative about the long-term impact of demonetisation. It says that it would be difficult to set the monetary policy based on the short-term disruptions caused by demonetization. It says that if the impact is transient as is being expected, then there could be a rebound in a growth in the long-term. But it is keeping its fingers crossed, and waiting for more data on which to base its assessment of the prospects of economic growth.