As was expected, demonetization has hurt activity across all corners of the economy. Purchasing Managers' Index (PMI) data shows that both manufacturing and services have contracted in December, according to a research report by HSBC Securities and Capital Markets (India) Pvt. Ltd, released on 5 January.
The PMI order-to-inventory ratio suggests that upcoming manufacturing activity will also remain weak. Input prices (such as oil) have been rising, but have not yet been passed on to final prices, suggesting that corporate margins have worsened. Meanwhile, investment intention volumes are at a one-decade low.
Real estate, logistics, hotels and tourism, electricity and mining have witnessed the bulk of the fall. Finally, after rising briefly after demonetization, consumer sentiments have fallen quickly over the last fortnight. On the back of the ongoing cash crunch, GDP is expected to grow 5% year -on-year (y-o-y) in the October-December quarter and 6% y-o-y in the January-March quarter, about 2 percentage points lower than expected before demonetization was announced.
After that, growth is expected to normalize gradually towards the 7% ballpark, but shy of the 7.5-8% range in FY18, due to adjustment costs that businesses and consumers face, in the process of formalization and digitization.
Both manufacturing and services PMIs contracted to 49.6 and 46.8 respectively, in December. Details within the composite PMI show that the output, new orders and employment sub-components posted below the 50 mark. The fall in the order-to-inventory ratio (1.02 in December versus 1.12 in November versus 1.20 in October) suggests that manufacturing activity will be subdued going forward.
Investment intention: For the October-December quarter, new investment intentions, as per the CMIE database, moderated in both value and volume terms. In volume terms, both government and private sector project intentions fell to a 10-year low.
Consumer sentiments: After posting a surprise improvement post-demonetization, the BSE and CMIE consumer sentiment indices have fallen over the last fortnight.
Implications
Demonetization has clearly hurt all corners of activity.
It's not surprising that data for mid-December showed that cash in circulation had contracted 60%, and news reports suggest that a 40% contraction persists even now.
True, the negative wealth shock may be limited (given media reports that about 97% of the demonetized currency has made its way back into banks), but we cannot ignore the adjustment costs which will be incurred by both businesses and consumers, in the process of formalization and digitization.
As such we expect growth to remain closer to 7% over FY18, an arm's length from the cherished 8% levels. The investment sector may take the longest to revive.
The mix in the July-September 'pre-demonetization' GDP was worrying. Growth was driven mainly by consumption while investment contracted for a third quarter in a row. After all, during lowcredit recoveries, investment takes long to revive.
And demonetization is only likely to worsen the mix. Just on the basis of lower growth over the last two quarters of FY17, the output gap (the slack in the economy) will likely remain negative for two quarters longer than was initially estimated, making it unattractive for investors to install new capacity.
On the back of the expectation of lacklustre investment growth, the Reserve Bank of India (RBI) could deliver a 25 basis point rate cut in the February meeting.
In arrangement with HT Syndication | MINT
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