Author: Dinesh Unnikrishnan
Date: March 15, 2017
A 10 March research paper prepared by the staff at the Reserve Bank of India (RBI)’s monetary policy department tells us that the 8 November demonetisation move by Prime Minister Narendra Modi has not done any major damage to the economy so far. Instead, the note ban promises several positives to the economy in the medium to long term, the preliminary assessment says. The RBI distances itself from the observations saying these are not its official views, but entirely belongs to those of the contributing staff.
The core theme of the paper is that “demonetisation has had some negative macroeconomic impact, which, however, has been transient as remonetisation has moved at an accelerated pace in last twelve weeks" — a view the RBI and government have maintained so far. More importantly, demonetisation is expected to have a positive impact over the medium to long term, the paper says.
“In particular, there is expected to be greater formalisation of the economy with increased use of digital payments. The reduced use of cash will also lead to greater intermediation by the formal financial sector of the economy, which should, inter alia, help improve monetary transmission,” it says.
Here are some of the observations in the paper:
Economy: Demonetisation impacted various sectors of the economy; however, the adverse impact, in general, was short-lived as it was felt mainly in November and December 2016. The impact moderated significantly in January and dissipated by and large by mid-February 2017, reflecting an accelerated pace of remonetisation.
The GVA growth in Q3 of 2016-17 was felt mostly in real estate and construction, but because of stronger growth in agriculture, manufacturing, electricity, and mining, the overall impact on GVA growth was modest. With remonetisation progressing at a fast pace, the adverse impact is expected to have reversed from the latter part of Q4 of 2016-17. GVA growth is estimated to recover significantly in 2017-18. But what about the protruding disconnect between GDP and other high frequency macro indicators? Read an earlier comment on this here.
Banks: With the return of SBNs (specified bank notes or invalidated old notes), currency in circulation declined and deposits with banks surged. The share of ‘investment in government securities’ on the asset side of banks’ balance sheet increased significantly. Large surplus liquidity led to a significant improvement in monetary policy transmission as reflected in a significant decline in deposit and lending interest rates. The sharp increase in low cost CASA (low cost) deposits by banks is expected to have increased banks’ net interest income.
But, will this huge inflow of deposits really benefit industry unless demand improves? Read a comment on this issue here.
FMCG companies: Reflecting the expected slowdown in sales and earnings, share prices of cash intensive sectors such as automobiles, FMCG, consumer durables and real estate declined sharply in November-December 2016. Most of these sectors have more than recovered the lost ground subsequently. In fact, the consumer durable sector outperformed the overall increase in the stock market post-demonetisation. The impact on the forex market was transitory.
Financial markets: The impact of demonetisation on the various segments of the financial market has varied. Overnight call money market rate remained within the policy corridor, but with a softening bias due to surplus liquidity at banks. After initial softening, G-sec yields increased significantly on two occasions, i.e., after the announcement of application of incremental cash reserve ratio (ICRR) and the status quo in monetary policy in December 2016. Thereafter, yields have moved in either direction on account of both domestic and external factors, including the change in monetary policy stance in February 2017, which was largely not expected by market participants.
Exports: Demonetisation has impacted some segments of the export sector such as readymade garments, and gems and jewellery. The impact, however, was transitory. Imports of gold increased sharply in November, but moderated in December.
Digital payments: There has been a significant improvement in the use of digital modes of payments post-demonetisation, although their base is still small. But didn’t the subsequent data reveal that cash is making a comeback to the system and small traders are shying away from embracing digital mode of payments. Read a comment here.
The MPD staff concludes the paper saying that given the partial information that is available post demonetisation so far, the analysis, especially of growth, is only preliminary in nature. It should, therefore, be possible to make an analysis in greater detail as more data becomes available in the coming months.
As the MPD staff rightly says, these are preliminary trends. What we know so far is that demonetisation gamble has certainly paid off handsomely for Modi and BJP as is evident from the historic victory in the Uttar Pradesh elections. The common man, in big numbers, hails this move as Modi’s big war on black money hoarders and cronies in the society, no matter what the short-term pain meant for him.
But, the impact in terms of meeting the original targets (recovering black money, ending corruption and a rapid transformation to a digital age) and on the larger economy will show only with a lag. For this, one must wait for the numbers, including those from the central bank.