Modi’s failed demonetization drive is showing

In less than a month’s time, the Reserve Bank of India (RBI) has been forced to cut the growth forecast by 50 bps from 7.6% to 7.1% for 2017. This has washed off the Government’s claims that demonetization would only have a temporary impact on the economy for one or two quarters. The Commerce Minister was even suggesting that the impact may not be felt beyond the present quarter. 

Coming within a few days of Nikkei PMI contraction to a 3 year low, this does not augur well for the economy or the Government’s claims. This reflects that further pain is in store for the economy on several counts.

The Reserve Bank has noted that the prices of wheat, gram and sugar are firming up. Limping back in the face of four years of droughts, the agricultural sector has been hit hard with the demonetization. A year of good monsoons should have seen food prices drop rather than rise sharply. The exact opposite has happened. Farmers were forced to delay sowing due to non-availability of cash. District Co-operative banks predominant in the rural areas are still not accepting old notes and new notes were not available. Banks were perennially out of cash for the vast majority of population, but had ready availability for certain influential sections.

Secondly, people got a glimpse of what it is like not being able to utilize one’s own money. It was a maze without exit for people with bank accounts. This will definitely have a huge psychological impact and people will think before spending money and may even prefer to save the cash withdrawn. The economy running primarily on consumer demand is likely to be hit further. Corporate demand essentially being non-existent, the economy is likely to take atleast 100-150 bps hit. This does not seem far-fetched given that the RBI was forced to revise its estimate for the entire 2017 within a matter of a month only.

Both the above factors will have a decidedly negative impact on demand and consumption. Infrastructure and B2B companies were anyways not in a great shape. Now B2C companies are likely to see their sales and profitability plummet.

As Dr. Paul Krugman mentioned the move is highly disruptive with negative short term impact and no long term benefits.