India: Demonetisation-induced slowdown in growth - NAB

The Indian economy experienced a demonetisation-induced slowdown in growth to 6.1% in the March quarter, with investment spending contracting, according to the analysts at NAB. 

Key Quotes

“Indian economic growth decelerated in the March 2017 quarter, with real GDP expanding by 6.1% in yoy terms. In the previous (December) quarter, the economy grew by 7%. It is likely that this outcome reflected the lagged impacts of India’s demonetisation program. If we look at GVA (gross value added) – which basically removes the impact of taxes and subsidies- then activity was an weaker 5.6%, the 4th consecutive quarterly decline.”

“In terms of the components by expenditure, consumption was the strongest, contributing 6.5%, although it was less than the December quarter outcome, 8.2%.  The next biggest contributor was the statistical discrepancy.  The most disappointing figure was investment, which detracted 0.64% from growth.  Net exports too detracted from growth. While one would have expected the demonetisation impact to have been felt more keenly in the December quarter, activity in that quarter seems to have been supported by favourable base effects and festive season spending.”

“The impact of demonetisation is more apparent when we examine growth by sector.  The worst performing sector was Industry, growing by 3.1%. Within industry, the labour-intensive construction sector (3.7%) went into reverse, and manufacturing slowed from 8.2% to 5.3%.”

“Industrial production (IIP) broadly lined up with the weak GDP outcome.  Yoy growth in IIP for the March quarter averaged 2.9%. The April reading showed only a modest uptick to 3.1%. The IIP use-based data reveal interesting trends. Capital and consumer durables output remain weak, while consumer nondurable output was robust. These trends broadly align with the weak investment and stronger consumption in the GDP series.”

“Monetary policy decision

At its 7th June Monetary policy meeting, the RBI: 

• Maintained the policy (Repo) rate at 6.25%

• Held the Reverse repo and MSF rate at 6%, and 6.5% respectively”

“Outlook

• NAB Economics is forecasting a 7.3% growth outcome in 2017 and 7.2% for 2018. The demonetisation induced slowdown should abate, with the removal of withdrawal restrictions and additional cash infusions. This should assist consumption expenditure, and be particularly supportive of the unorganised, cashreliant sector of the economy.  Further, lowering of banks’ lending rates, and structural reforms such as the Insolvency and Banking Code and the upcoming GST (which will take effect from the 1st of July, 2017), should be supportive of growth. Against that, stresses in India’s banking system could provide a headwind to growth - mentioned in the RBI’s monetary policy statement.
• NAB Economics is forecasting one more rate cut from 6.25% to 6% (possibly in October), which would be last of the current rate cutting cycle.”

“The risks to our forecasts are evenly balanced. A faster-than expected decline in inflation could prompt the RBI to move in August, particularly if activity indicators remain muted.  Conversely, upside risks from fiscal slippages (e.g. from the farm loan waiver programs), imported inflation due to global economic and financial factors, and the impacts of the 7th Pay Commission might stay the RBI’s hand.  The GST is expected not to have a significant impact on inflation, as most of the items in the CPI basket are expected to attract a lower tax impost than is currently the case.  The RBI’s tone with regard to GST is instructive: they indicated it would ‘not have a material impact’, a contrast to the April meeting when it saw possible ‘upside risks’ on account of the GST.”