ECONOMY | Staff Reporter, India

India's demonetisation could hurt economy

GDP could fall by 0.7-1.0ppt.

The government’s decision to abolish pre-existing stock of high denomination currency notes (demonetization) and issue new notes (remonetization) can have a mixed impact on the macro economy over a year, said HSBC Global Research,

According to the research house, long-term gains will be realised if this bold move is followed up by other reforms (like incentivizing digital adoption and tackling other shelters for unaccounted money).

Using the cash elasticity of GDP, it estimates that over a year, economic growth can fall by 0.7-1.0ppt, with the maximum impact in the immediate two quarters, which will see a large contraction in ‘effective’ money supply.

Alternate estimates based on consumer behaviour also point to a similar ballpark.

"Our estimation of the Phillips curve points to a ~20bp fall in CPI inflation. Expectations of lower growth and inflation solidify our 25bp rate cut call for the current fiscal year,"it said.

Here's more from HSBC:

As the old INR500/1,000 notes make their way to the banking sector, deposits are likely to swell and lending and deposit rates could fall by year-end.

Government bonds have already seen an impressive rally. The RBI will need to suck out the large increase in liquidity, lest it leads to risky lending; we expect it to use of a variety of instruments (reverse repo and MSS issuances for temporary liquidity; OMO sales for permanent liquidity).

There is much talk of a large one-time fiscal bounty for the government.

However, neither its timing nor its quantum can be taken for granted. As long as the RBI is open to exchanging old notes for new ones, it cannot extinguish the liability and transfer funds to the government.

Given the legal status of currency notes, it comes as no surprise that so far, the RBI has not officially signed up for an end date for the scheme. 

While we expect imports of consumer goods to fall, we find that this could be easily offset by higher gold demand. Our FX strategists see the rupee weakening versus the USD to 68.0 by end-2016 and 69.5 by end-2017. All told, the short run is indeed a mixed bag.

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