Economic impact of Demonetization

The debate over the decision of sudden cancellation of two high value currency notes on 8th November has now moved over to the effect on the rate of growth of GDP. While different estimates indicate a sharp drop in GDP growth rate in the fiscal 2016-17 India’s Finance Minister cited robust tax collection as a sign of little or no impact on GDP growth.
But all advance estimates of GDP growth rate indicate a fall in 20167-17. HSBC estimated a substantial 1.3% fall in GDP growth rate in 2016-17 – 6.3% against 7.6% in 2015-16. The advance estimate of India’s Central Statistics Office (CSO) calculated GDP growth at 7.1% in the current year, less by 0.5% than that in 2015-16. Reserve Bank of India, too, placed growth rate estimate at 7.1% lower than 7.6% predicted earlier.
According to CSO manufacturing growth will be 7.4% a fall from 9.4% in the previous year and mining and quarrying will see a contraction by 1.8% against a 7.4% increase in 2015-16. However, good monsoon will see 4.1% rise in agriculture, forestry and fishing sector. CSO advanced estimates are based on data available for certain months and is used by the Government to calculate tax revenue and deficit figure.
It was rightly pointed out by India’s chief statistician T C A Anant that the year 2016-17 was no ordinary year. The note ban had a major disruptive effect. That is why in the advanced estimate CSO has not considered bank deposits and credit data for November, it being a month of high volatility due to the note cancellation move by the Government.
The widespread feeling among the rating agencies is that the note click here cancellation decision will pull down the GDP growth rate notwithstanding the boost in tax revenue as revealed by the Finance Minister. Fitch Rating lowered GDP growth forecast to 6.9% from its earlier prediction of 7.4%, Morgan Stanley reduced it to 7.4% from 7.7%, India Ratings and Research to 6.8% from an earlier 7.8% growth rate.
The tax collection data during the nine months between April to December, both for the Centre and the States, however, was encouraging. VAT collections grew 26% in Maharashtra in November and 17% in December – only 3 of 17 states for whom the data is available showed a decline in VAT collections; Direct taxes for the Centre rose 12% and indirect taxes 25%. Increase in direct taxes collection is in line with the 2016-17 budget targets. Indirect taxes grew at more than double the budgeted 10.8%. That is good news since the deficit figure will come down sharply when the Government places its budget on February 1st.
Tax buoyancy is expected to increase from next year onwards. The note cancellation move has forced incomes, hitherto hidden, to come into the taxation net. With the cash trapped in the banking sector the widespread tax evasion will come down boosting the revenue of Centre and States. With the new indirect tax structure GST, likely to be implemented before September 2017, the tax buoyancy will increase further.
It seems that after the initial shock of demonetization Indian economy will gain from the audacious move. By how much will depend on the efficiency of the administration and banking system.

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