State of the Indian Economy : post-demonetisation

The novel experiment of the Indian Government to cancel two high value currency notes – Rs 1000 and Rs 500 – in November had adversely affected the economy in December. This was however widely expected. Manufacturing sector contracted in December as new work orders and output took a knock for the first time in 2016, according to the Nikkei Markit Manufacturing Purchasing Managers’ Index (PMI).The month after demonetisation saw the economy tumbling down. PMI, an indicator of manufacturing activity fell to 49.6 in December compared to 52.3 in November. The index came lower than the threshold level of 50 which separates expansion from contraction. Evidently the first full month after the sudden decision to demonetise the high value currency notes affected the Indian economy adversely.
In November India had cancelled use of Rs 500 and Rs 1000 notes and asked people to exchange the notes against newly issued legal tenders in the denomination of Rs 500 and Rs 2000. The sudden announcement did not immediately affect the economy but December saw Indian firms reeling under pressure of cash crunch. Cash flow issues resulted in lower purchasing hence a steep decline in PMI. The participants to the PMI survey mostly blamed the withdrawal of high-value rupee notes for the downturn as cash shortage in the economy reportedly resulted in fewer levels of new orders.
The automobile sector saw downturn across the segments. The leader in the sector, Maruti Suzuki saw a 4.4% fall in sale of passenger cars. However it salvaged the position by 47.1% growth in export sales and ended December with a mere 1% fall in sales.
Toyota Kirloskar managed to record a decent growth in sales on the back of its new launches. Its popular Innova and Fortuner brands helped Toyota to record 29% rise in sales in December.
Among the manufacturers which faced a decline in sales are M&M, Bajaj Auto, Ashok Leyland, Hero Motorcycles and Hyundai, the second largest car maker in India. The demand from the rural areas fell more than those in the urban areas reflecting the impact of note cancellation and resultant liquidity click here tightening.
Meanwhile, after the completion of the 50-day grace period of exchange of old notes, Prime Minister Narendra Modi announced some sops mainly targeted at the poor who are part of India’s vast cash based informal market. Important among the sops announced are promise of a fixed 8% interest on savings in 10-year bank deposits  for senior citizens, interest subsidy for affordable houses and benefits for pregnant women.

Taking a hint from the Prime Minister to reduce rates India’s largest bank, State Bank of India, reduced its lending rate by 90 basis points to 8%. Other banks too followed suit. The excess cash in the banking system also encouraged banks to reduce base lending rates.
The banking services are now near normal though restriction on withdrawal of money remains in place. Predictably the Government does not want people to accumulate cash once again. In addition the income tax department with investigators from ED are busy checking the bulk deposit of cash in banks. Clearly the financial year 2016-17 will see a sharp increase in direct tax collection from those who had been hiding their incomes from tax sleuths.
A major casualty of the note ban step will be delay in implementation of India’s much awaited Goods and Services tax (GST). Once introduced GST will ensure higher compliance of indirect tax administration. It seems that the implementation of GST may now be delayed by three months at least and may be in place from the month of June, the second quarter of 2017-18.
India’s forthcoming budget session of Parliament will be critical. The Government has already announced that Union Budget will be placed before the House on February 1st instead of usual at the end of February. The Budget Session is expected to be called by the end of January. By then the preliminary collation of demonetisation effect will be available. The exact effect of the Government’s decision will then be captured in the Budget to be placed by India’s Finance Minister Arun Jaitley.

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