GDP growth in 2017-18 projected at 6 ¾ to 7 ½ percent post-demonetisation

| Updated: Jan 31, 2017 19:54 IST

New Delhi [India], Jan.31 (ANI): The government on Tuesday said that the adverse impact of demonetisation on GDP growth will be transitional. Presenting the Economic Survey 2017 in Parliament today, Union Finance Minister Arun Jaitley stated that once the cash supply is replenished, which is likely to be achieved by the end March 2017, the economy would revert to normal, and therefore in that eventuality, real GDP growth in 2017-18 is projected to be in the range of 6¾-7½ percent. The Economic Survey points out that demonetisation will have both short-term costs and long-term benefits as detailed in the attached table. Briefly, the costs include a contraction in cash money supply and subsequent, albeit temporary, slowdown in GDP growth; and benefits include increased digitalization, greater tax compliance and a reduction in real estate prices, which could increase long-run tax revenue collections and GDP growth. On the benefits side, early evidence suggests that digitalization has increased since demonetisation. On the cost side, effective cash in circulation fell sharply although by much less than commonly believed - a peak of 35 percent in December, rather than 62 percent in November since many of the old high denomination notes continued to be used for transactions in the weeks after November 8. Additionally, remonetisation will ensure that the cash squeeze is eliminated by April 2017. The cash squeeze in the meantime will have significant implications for GDP, reducing 2016-17 growth by ¼ to ½ percentage points compared to the baseline of 7 percent. Recorded GDP will understate impact on informal sector because, for example, informal manufacturing is estimated using formal sector indicators (Index of Industrial Production). These contractionary effects will dissipate by year-end when currency in circulation should once again be in line with estimated demand, which would also allow growth to converge to a trend by FY 2017-18. The Economic Survey states that the weighted average price of real estate in eight major cities which was already on a declining trend fell further after November 8, 2016 with the announcement of demonetization. It goes on to add that an equilibrium reduction in real estate prices is desirable as it will lead to affordable housing for the middle class and facilitate labour mobility across India currently impeded by high and unaffordable rents. The survey suggests a few measures to maximize long-term benefits and minimize short-term costs. One, fast remonetisation and especially, free convertibility of cash to deposits including through early elimination of withdrawal limits. This would reduce the GDP growth deceleration and cash hoarding. Two, continued impetus to digitalization while ensuring that this transition is gradual, inclusive, based on incentives rather than controls and appropriately balancing the costs and benefits of cash versus digitalization. Three, following up demonetisation by bringing land and real estate into the GST. Four, reducing tax rates and stamp duties. And finally, an improved tax system could promote greater income declaration and dispel fears of over-zealous tax administration. According to the survey, the impact of demonetisation shows that as far as money and interest rates were concerned, cash declined sharply, but would recover and settle at a lower level. The survey also said that bank deposits increased sharply and predicted that deposits will decline, but probably settle at a slightly higher level. RBI's balance sheet largely unchanged: return of currency reduced the central bank's cash liabilities but increased its deposit liabilities to commercial banks It said that the RBI's balance sheet will shrink, after the deadline for redeeming outstanding notes. Interest rates on deposits, loans, and government securities declined; implicit rate on cash increased, it said, adding that loan rates could fall further, if much of the deposit increase proves durable On the issue of financial system savings, the survey said it has increased to the extent that the cash-deposit ratio falls permanently. It also said that corruption and other underlying illicit activities could decline, provided incentives for compliance improve. On unaccounted income/black money, the survey says that the stock of black money fell, as some holders came into the tax net and added that this formalisation should reduce the flow of unaccounted income. On the issue of private wealth, the Economic Survey revealed that private sector wealth has declined since some high denomination notes were not returned and real estate prices fell It predicted that wealth could fall further if real estate prices continue to decline There was no effect on public sector wealth, it said, adding that the government and the Reserve Bank of India's wealth will increase when unreturned cash is extinguished, reducing liabilities It said that digital transactions amongst new users (RuPay/ AEPS) increased sharply; existing users' transactions increased in line with historical trend and indicated that there could be some return to cash as supply normalizes. It said that digital revolution will continue On real estate, it said that prices have declined, as wealth fell while cash shortages impeded transactions, and added that prices could fall further as investing undeclared income in real estate becomes more difficult. It said that the tax component could rise, especially if GST is imposed on real estate With regard to the broader economy, the Economic Survey said that there could be job losses, decline in farm incomes, social disruption, especially in cash-intensive sectors, but added that once remonetisation kicks in, the economy would stabilize. On GDP, the survey said growth slowed, as demonetisation reduced demand (cash, private wealth), supply (reduced liquidity and working capital, and disrupted supply chains), and increased uncertainty, and added that in the long term, this could be beneficial if formalization increases and corruption falls It said that over time as the economy becomes more formalized, underestimation will decline. Recorded GDP will also be overstated because banking sector value added is based (inter alia) on deposits which have surged temporarily. Informal output could decline, but recorded GDP would increase as the economy becomes more formalized. It said that income taxes rose because of increased disclosure. Payments to local bodies and discoms increased because demonetised notes remained legal tender for tax payments/clearances of arrears. Indirect and corporate taxes could decline, to the extent growth slows. It said over the long run, taxes would increase as formalization expands and compliance improves. It said credibility will be strengthened if demonetisation is accompanied by complementary measures. It said that early and full remonetisation is essential. Tax arbitrariness and harassment could attenuate credibility. (ANI)