Post DeMo, GDP growth in 2017-18 projected at 6.75 to 7.5 percent

Demonetisation costs include a contraction in cash money supply and subsequent, albeit temporary, slowdown in GDP growth; benefits include increased digitalisation

GN Bureau | January 31, 2017


#demonetisation   #Arun Jaitley   #Economic Survey   #GDP growth  


Finance minister Arun Jaitley on Tuesday said that post demonetisation, once the cash supply is replenished, which is likely to be achieved by end March 2017, the economy would revert to the normal.  Therefore, the real GDP growth in 2017-18 is projected to be in the range of 6.75-7.5 percent.

The Economic Survey presented in parliament points out that demonetisation will have both short-term costs and long-term benefits. Briefly, the costs include a contraction in cash money supply and subsequent, albeit temporary, slowdown in GDP growth; and benefits include increased digitalisation, greater tax compliance and a reduction in real estate prices, which could increase long-run tax revenue collections and GDP growth.

On the benefits side, early evidence suggests that digitalisation has increased since demonetisation. On the cost side, effective cash in circulation fell sharply although by much less than commonly believed – a peak of 35 percent in December, rather than 62 percent in November since many of the old high denomination notes continued to be used for transactions in the weeks after November 8.

Additionally, remonetisation will ensure that the cash squeeze is eliminated by April 2017. The cash squeeze in the meantime will have significant implications for GDP, reducing 2016-17 growth by 0.25 to 0.5 percentage points compared to the baseline of 7 percent. Recorded GDP will understate impact on informal sector because, for example, informal manufacturing is estimated using formal sector indicators (index of industrial production). These contractionary effects will dissipate by year-end when currency in circulation should once again be in line with estimated demand, which would also allow growth to converge to a trend by FY 2017-18.

Sector

Impact

 

Effect through end-December

Likely longer-term effect

Money/interest rates Cash declined sharply Cash will recover but settle at a lower level
  Bank deposits increased sharply Deposits will decline, but probably settle at a slightly higher level
  RBI's balance sheet largely unchanged: return of currency reduced the central bank’s cash liabilities but increased its deposit liabilities to commercial banks RBI's balance sheet will shrink, after the deadline for redeeming outstanding notes
  Interest rates on deposits, loans, and government securities declined; implicit rate on cash increased Loan rates could fall further, if much of the deposit increase proves durable
Financial System Savings Increased Increase, to the extent that the cash-deposit ratio falls permanently
Corruption (underlying illicit activities)   Could decline, if incentives for compliance improve
Unaccounted income/black money (underlying activity may or may not be illicit) Stock of black money fell, as some holders came into the tax net Formalization should reduce the flow of unaccounted income
Private Wealth Private sector wealth declined, since some high denomination notes were not returned and real estate prices fell Wealth could fall further, if real estate prices continue to decline
  Public Sector Wealth No effect. Government/RBI's wealth will increase when unreturned cash is extinguished, reducing liabilities
Formalization/ digitilisation Digital transactions amongst new users (RuPay/ AEPS) increased sharply; existing users’ transactions increased in line with historical trend Some return to cash as supply normalises, but the now-launched digital revolution will continue
Real estate Prices declined, as wealth fell while cash shortages impeded transactions Prices could fall further as investing undeclared income in real estate becomes more difficult;  but tax component could rise, especially if GST imposed on real estate
Broader economy Job losses, decline in farm incomes, social disruption, especially in cash-intensive sectors Should gradually stabilize as the economy is remonetized
GDP Growth slowed, as demonetisation reduced demand (cash, private wealth), supply (reduced liquidity and working capital, and disrupted supply chains), and increased uncertainty Could be beneficial in the long run if formalization increases and corruption falls
  Cash-intensive sectors (agriculture, real estate, jewellery) were affected more. Recorded GDP will understate impact on informal sector because informal manufacturing is estimated using formal sector indicators (Index of Industrial Production). But over time as the economy becomes more formalized the underestimation will decline. Recorded GDP will also be overstated because banking sector value added is based (inter alia) on deposits which have surged temporarily Informal output could decline but recorded GDP would increase as the economy becomes more formalized
Tax collection Income taxes rose because of increased disclosure Payments to local bodies and discoms increased because demonetised notes remained legal tender for tax payments/clearances of arrears Indirect and corporate taxes could decline, to the extent growth slows Over long run, taxes should increase as formalization expands and compliance improves
Uncertainty/ Credibility Uncertainty increased, as firms and households were unsure of the economic impact and implications for future policy Investment decisions and durable goods purchases postponed Credibility will be strengthened if demonetisation is accompanied by complementary measures. Early and full remonetisation essential. Tax arbitrariness and harassment could attenuate credibility


The Economic Survey states that the weighted average price of real estate in eight major cities which was already on a declining trend, fell further after November 8, 2016 with the announcement of demonetisation. It goes on to add that an equilibrium reduction in real estate prices is desirable as it will lead to affordable housing for the middle class and facilitate labour mobility across India currently impeded by high and unaffordable rents.

The Survey suggests a few measures to maximise long-term benefits and minimise short-term costs. One, fast remonetisation and especially, free convertibility of cash to deposits including through early elimination of withdrawal limits. This would reduce the GDP growth deceleration and cash hoarding. Two, continued impetus to digitalisation while ensuring that this transition is gradual, inclusive, based on incentives rather than controls and appropriately balancing the costs and benefits of cash versus digitalisation. Three, following up demonetisation by bringing land and real estate into the GST. Four, reducing tax rates and stamp duties. And finally, an improved tax system could promote greater income declaration and dispel fears of over-zealous tax administration.
 

Comments

 

Other News

On a personal note: DIVINE

An underground rapper who grew up on Mumbai streets, Divine spins his music around his environment and poverty. His breakout single, ‘Meri Gully Mein’, along with fellow rapper Naezy caught Bollywood’s attention. The Hindi film ‘Gully Boy’ is inspired by their lives and gr

The role model for an IAS officer

Anil Swarup, an IAS officer of Uttar Pradesh cadre who retired in 2018, is a model bureaucrat who retained his optimism right till the end of service and exemplified dedication and commitment. His excitement at the opportunities that a job in the IAS provided is evident on every page of his new book publis

Reform of the civil services: At home and away

The question of reform of the civil services has been debated extensively at all levels at least over the last five to six decades after independence. Indeed, it was soon perceived that the Indian Administrative Service (IAS) may not be well equipped to deal with the problems of an emerging developing coun

The greatest challenge for any government

Shouting vengeance at all and sundry while wriggling out of holes of our own making seems to be our very special national characteristic. Some recent instances are illustrative of this attribute. A number of business tycoons with thousands of crores of unresolved debts have fled abroad with the government

The mysterious case of CBI’s legality

The Central Bureau of Investigation (CBI) came into existence, based on a Resolution of the home ministry, dated April 1, 1963 – a sheer coincidence that it also happens to be April Fool’s day. Over the past few months, we have seen the CBI live up to its founding day with great zeal, being i

The Evolution of Modi

Gujarat was passing through a turbulent phase in the 1980s. The decade began middle class agitations against new reservation policies, and the caste friction turned communal under the watch of chief minister Madhavsinh Solanki, alienating majority of urban population on both counts. The ground was ripe for

Current Issue

Current Issue

Video

CM Nitish’s convoy attacked in Buxar

Opinion

Facebook    Twitter    Google Plus    Linkedin    Subscribe Newsletter

Twitter