Demonetization likely to impact India’s GDP growth in FY2017 on reduced consumption

The recently announced demonetization move by the Prime Minister of India, Narendra Modi, in order to curb the menace of black money is expected to have a detrimental effect on the country’s gross domestic product (GDP) in the fiscal year 2017, owing to reduced consumption amid an environment of liquidity crunch.

The demonetization will likely shave 0.40ppt from India’s GDP growth in FY2017 mainly due to reduced consumption amid a cash crunch. However, over the long term, the move will have far-reaching positive implications, ANZ reported.

According to the World Bank, India’s shadow economy accounted for 23 percent of GDP in 2007. Using this ratio as the benchmark, the value of unaccounted money would amount to nearly USD450 billion. While not all of it will be ploughed back into the formal economy, it will still be significant to help bridge the government’s projected USD1-1.5 trillion spending on infrastructure.

Further, old currency notes that do not get exchanged, due to factors like tax liability or fears over black money revelation, will ultimately be invaluable, costing the economy a net loss of INR5 trillion; however, this will likely reduce the Reserve Bank of India’s (RBI) liabilities, allowing for a special dividend payment to the government.

Furthermore, over the medium term, the demonetization will also discourage cash hoarding, leading to higher tax compliance and a widening of the tax base.

"Overall, India’s demonetization has significant potential to lift its potential growth through a more transparent economy," ANZ commented in its report.

Meanwhile, the USD/INR remained bearish at 68.03, down 0.08 percent.