Bouncing Back From Cash Ban, India Chasing V-Shaped Recovery

  • Central bank, goverment officials optimistic about growth
  • Concerns that GDP masks extent of damage to small businesses

What to Expect From India's Economic Numbers

India’s surprising economic strength last quarter will only renew debate over how much its unprecedented cash ban has curtailed growth and how quickly activity will bounce back.

While the Reserve Bank of India and the government are backing a sharp V-shaped recovery, analysts including those at the local unit of Moody’s Ratings predict a slower turnaround after Tuesday’s growth estimates showed India shrugged off the impact of the sudden withdrawal of 86 percent of its currency with only a brief slowdown.

Read full details of latest India GDP estimate here

The Reserve Bank of India has already signaled an end to its interest rate easing cycle and with growth set to gather pace it’s likely to boost inflationary pressures in the coming months. And as newly-printed bills hit the banking system, replacing the old 500 and 1,000 rupee notes that were voided overnight on Nov. 8, the government is expecting a quick rebound.

Indian sovereign government bond yields appear to have bottomed out and are headed higher as investors and analysts including those at Morgan Stanley expect a rate hike most probably in 2018. Expectations of higher rates from an inflation-fighting central bank are also helping the rupee, which has recovered after hitting a record low in November.

Still Smarting

Yet India’s economy is still smarting over Prime Minister Narendra Modi’s shock currency withdrawal that saw India’s vast shadow economy stall and forced millions to spend days lining up to withdraw cash or exchange their worthless notes.

The costs have been huge, especially for the informal sector which does the bulk of its transactions in cash. There was a sharp dip in consumption towards the end of 2016, highlighted by a contraction in overall auto sales in December. Industrial growth was hit and demand for loans from companies remains at a record low. Along with uncertainty over the introduction of a nationwide sales tax due later this year, there are few signs that much-needed private sector investment will spearhead a recovery.

Some economists and lobby groups say official growth figures do not account for job and revenue losses at small companies. 

Aditi Nayar, principal economist at ratings agency ICRA Ltd. said the overall numbers may not capture the full impact of the note ban because growth data relied heavily on the formal sector, which weathered the effects much better than the informal sector. "Subsequent estimates that draw from wider data sources may well revise third-quarter growth downward," she said.

Optimistic Outlook

But there are growing positive signs. Economists say a bumper harvest of summer crops that will boost rural incomes, along with government spending and a recovery in demand for financial services and government spending, should combine to shore up activity in the economy in the coming months.

"While the immediate recovery is proving to be V-shaped, we expect a lingering impact over the next two or three quarters as the shock will only fade over time," said Teresa John, economist at Nirmal Bang Securities Ltd. "We expect a strong recovery in the second half of the financial year 2017/18 with growth likely to pick up to 7.3 percent in the year to March 2018 from an estimated 6.5 percent in 2016/17."

India is expected to grow at 7.1 percent in the year through March -- the slowest pace since 2014 but still among the fastest in the world, and easily beating the 6.8 percent median estimate in a Bloomberg survey of 30 economists. Gross domestic product growth slowed to 7.0 percent in October-December from a year earlier, its slowest pace since the January-March quarter of 2015.

A private survey of India’s manufacturing sector showed activity growing in February. The Nikkei India Purchasing Managers’ Index rose to 50.7 last month from 50.4 in January, the second month of expansion after December’s contraction. The S&P BSE Sensex gauge has rebounded from a six-month low in December to come within 3 percent of its life-time high reached in January 2015.

Investment Outlook

Growth will rebound after the slowdown, RBI Governor Urjit Patel told CNBC-TV18 on Feb. 17. That was also the view of Finance Ministry advisers in a pre-budget report on Jan. 31, though they also warned of "real and significant" costs that "may be minimized in official GDP."

"Looking ahead, the cash shortage will continue to hamper activity -- whether or not this shows up in the official GDP figures is a different matter," said Shilan Shah, India economist at Capital Economics, Singapore. "But the most acute impact from demonetization may already have passed."

Priyanka Kishore, lead Asia economist at Oxford Economics, Singapore, expects a gradual "U"-shaped recovery for the economy, as private investment languishes. "There is no sign of a turnaround in private investment that has been a drag on growth since late 2015," Kishore said.

Whether it will be a sharp or a more gradual rebound, most economists are confident India will retain its crown as one of the fastest-growing major economies. That, though, will not be enough for a country that needs a sustained period of double digit growth to provide jobs.

"The potential for 10 percent growth has improved from two years ago but it still remains a potential, not a reality in 2017 or 2018," Sean Yokota, head of Asia strategy at SEB AB, wrote in a note after a recent India visit.

— With assistance by Ravil Shirodkar

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