India Watch

A silver lining ahead for the Indian economy?

A series of impending government reforms is hoped to bring growth in the Indian economy over the coming years. However, regulations such as the planned Goods and Services Tax (GST) need a stronger push.

Following the Indian government’s landmark demonetisation campaign announced on 8 November, there was a clear decline in business activities at the end of 2016. The second such drive in the country post-independence was intended to improve the economy and to put an end to the black market.

The demonetisation and its impact

Demonetisation has so far provoked a mixed response. While it may ultimately be good for the economy as a ‘cleaning’ exercise, the effects are not likely to be felt until the longer-term. The exchange of INR 500 and INR 1,000 notes meant there was an immediate and severe impact on currency availability, as more than 80% of the cash in circulation was withdrawn from the system. After the announcement, only INR 100 and INR 2000 notes were available.

The lack of cash in the system meant that overall economic activity was subdued in November and December 2016. Banks are struggling to manage the change and it will take some time before the average person has easy access to the new currency notes.

One long-term positive effect of demonetisation will be the removal of fake currency floating in the market. The real estate secondary market will also feel major impacts where the use of black money has been rampant. Coupled with demonetisation, the Benami Transactions (Prohibition) Amendment Act 2016 will further help the government curb illegal transactions and the use of black money.

Technology-driven digital wallet companies and e-commerce players have been the biggest beneficiaries of the demonetisation drive so far, with digital wallet companies seeing a more than 100% jump in their consumer base in the last two months of 2016.

Increase in consumption is expected

While demonetisation has affected businesses in the short-term, strong private consumption is likely to keep up the current growth momentum. The Asian Development Bank (ADB) forecasts growth for India in FY 2016 to remain at 7.4%, while the majority of industry evaluations expect GDP to expand by 7.2%.

Although there has been a reduction in business activity due to demonetisation, the decline in inflation has kept hopes for the coming months high. In November, the consumer prices index (a measure of the average change over time in the prices paid by urban consumers for a basket of consumer goods and services) fell 0.15% from the previous month, primarily because of lower prices for food and beverages. Inflation also continued to fall in November, dropping from October’s 4.2% to a two-year low of 3.6%.

The wholesale price index (WPI), a measure of the price of a representative basket of wholesale goods, rose 0.11% in November from the October level, while annual average wholesale inflation rose from 1.1% in October to 1.6%. The rise in WPI was driven by higher prices for fuel and power products. Meanwhile, wholesale price inflation fell from 3.4% in October to 3.2% in November.[1]

If these levels of inflation continue, it will lead to increased consumption and retail transactions in following months.

Some positivity in trade data

India’s merchandise exports grew for the third consecutive month in November with 20 out of the 30 export sectors registering a growth in outward shipments. However, higher imports due to a spike in gold purchases led to a sharp increase in the trade deficit.[2]

Government data shows merchandise exports grew 2.29% year-on-year to US$20 billion in November, while imports expanded 10.44% year-on-year to US$33 billion. India’s trade deficit thus widened to US$13 billion in November from a provisional US$10 billion in October, according to the data. The trade gap in November 2015 was US$10 billion.[3]

Further reform pushes needed

As investments rise, there will be a need for a further push on reforms to boost growth, although effective implementation is critical. Key reforms such as the proposed Goods and Services Tax (GST) should see the light of day, although the GST council's meeting in the third week of December raised grave concerns about the planned 1 April 2017 implementation date.[4]

Once implemented, the GST will replace a myriad of consumption and sales taxes. By reducing tax cascading, it will boost competitiveness, investment and economic activity in the medium-to-long term.

As the new year gets going, all eyes will be on the Union Budget for 2017. We hope to see further announcements aimed at propelling investment into social infrastructure programmes for the country. A focus on raising public spending on education, health, water, energy and transport infrastructure will improve access to basic amenities and services. In turn, this will reduce the bottlenecks that impede investment. 

Author: Prashant Mehra

Sources:

  1. Focus Economics - India Economic Outlook
  2. India Times - India’s exports up 2.2% in November, gold imports rise 23%
  3. Reuters
  4. Firstpost - GST council meeting: FM Jaitley 'trying best' for 1 April rollout even as logjam continues