By Invitation. Too soon to gauge note ban impact

On November 8, India will complete a year in the post demonetisation era. Possibly this date will go down in history like July 24, 1991, when Manmohan Singh presented the epochal budget.

A quick glance at demonetisation history suggests it’s a rare experiment in a country of the size of India.

Sector-wise growth trends reveal that both agriculture and the industrial sector were hit, post demonetisation. While the lower growth rate of the agriculture sector was primarily driven by exogenous factors like deficient rainfall across major parts of the country, there could be issues related to the cash crunch too.

Small and marginal farmers, who mostly depend on cash transactions, faced difficulties in terms of procuring inputs for farming — be it seeds, fertiliser or labour. Similarly, cash shortage in the rural areas led to reduced demand for farm products.

Demand and supply-side shocks in the agriculture sector, coupled with droughts in several parts of the country, have pushed agricultural growth down to 2.3 per cent in the latest quarter. Therefore, it is difficult to isolate the impact of demonetisation on the sector.

Within the industrial sector, there has been a declining growth trend in the manufacturing sector. Average monthly growth in IIP during October 2016-August 2017 was 2.9 per cent as compared to 5.3 per cent in the corresponding period a year before.

The Manufacturing Purchasing Managers’ index (PMI), an indicator of economic activity, contracted for the first time in December 2016. This was primarily on account of rising inventory and reduced consumption expenditure. Sales of FMCG and automobiles declined between November 2016 and January 2017.

Similar to the agriculture sector, the effect of demonetisation on the growth rates in manufacturing and the industrial sector as a whole cannot be isolated from the other factors, at least from Q1 of FY2018, owing to stock clearing because of GST implementation from Q2.

However, the latest IIP figures (August 2017) for the manufacturing sector point towards a recovery. Manufacturing grew at 3.1 per cent year-on-year (y-o-y), up from -0.3 per cent a month before. Overall, the Industrial Outlook Survey of Reserve Bank of India for Q3 FY2018 shows improvement, albeit marginally.

The services sector, which was considerably resilient to the effects of demonetisation, posted higher growth in Q4 FY2017 and Q1 FY2018. Public administration, defence and other services posted strongest growth in Q4 FY2017 (17 per cent) as compared to the past eight quarters’ performance. This has also been fuelled by the government’s high spending in the last quarter.

As deposits in banks surged, the surplus liquidity conditions contributed to lowering of costs on deposits, which allowed banks to also reduce lending rates.

Lower costs were also accompanied by increased interest income: banks’ net interest income from increased deposits is estimated at about ₹45 billion in the quarter after demonetisation. Financial services, along with real estate and business services, registered a strong growth of 6.4 per cent in Q1 FY18, as compared to 2.2 per cent a quarter ago.

In a bid to encourage “less-cash” economy and to achieve the target of 25 billion digital transactions in 2017-18, the government and the RBI came out with various measures to promote digital payments — viz. reduction in the merchant discount rate and point of sale fees, waiver of charges for small value transactions under IMPS, partnership with major technology companies to make digital platforms available all over the country, etc.

This gave a fillip to transactions through systems such as NEFT, debit and credit cards, cheques, prepaid wallets, UPI and mobile banking, etc. In the month of December 2016, 957 million transactions were made as compared to 671 million in the preceding month.

The momentum continued up to March 2017, but the volume has since come down to 862 million transactions in July 2017, indicating a moderation of the initial rapid growth. Hence, while the volume of transactions has definitely been boosted by demonetisation, the inference over its sustained use and transmission to the cash-intensive sectors can only be made over a longer period of time.

Given the magnitude of the exercise, demonetisation was expected to cause some short-term pains along with some long-term benefits. Unfortunately, the debate today has turned more into an ideological one rather than one backed by rigorous scientific enquiry. It is too premature to analyse the overall economic impact of demonetisation, just within a year.

The writer is Partner – Public Finance & Economics, PwC India

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