The sharp drop that has been noticed in economic activity following the demonetisation of Rs 500 and Rs 1,000 notes bodes ill for growth this year. This is bound to reflect in GDP (or GVA) figures for 2016-17. Though one cannot predict how much the growth rate will drop, one can assume that it will not hit the optimistic estimates of 8 per cent being forecast in some quarters after a good monsoon year. The Reserve Bank of India had indicated gross value added (GVA) growth of 7.6 per cent in 2016-17 in its last monetary policy, but actuals could be in the range of 7-7.5 per cent. (GDP is GVA plus taxes minus subsidies).

However, here’s the good news. Any artificial constriction in economic activity is bound to result in a fast spring-back once the negative conditions reverse themselves, for there is no fundamental lack of consumption demand in the Indian economy.

So here’s my forecast, based purely on estimates about how soon the artificial constraint induced by cash shortage will take to reverse itself: I predict a V-shaped economic recovery from the first quarter of 2017-18.

Let’s come back to the present. There is little doubt that public anger is rising right now as ordinary people line up for cash before ATMs and bank branches. The cash crunch has impacted day-to-day transactions and incomes at the bottom end of the pyramid, which means kirana merchants, vegetable vendors, small restaurants, autos and cabbies, and road transport operators are badly hit. Demonetisation has also halted realty deals suddenly, especially second-sales, which are often accompanied by payments in black money.

People are also holding back on basic spending right now as demonetisation has stoked their hoarding instinct: they are hoarding cash as they are gripped by a shortage psychosis.

However, anecdotal evidence suggests that as cash gets pumped in larger amounts into the economy, this hoarding instinct will abate, and people will start spending.

State Bank of India chairperson Arundhati Bhattacharya expects ATMs to be recalibrated to handle the new Rs 2,000 and Rs 500 notes in 10 days. Assuming it will be the same for all banks, this means ATM and bank queues will start shortening by the end of November. The fear psychosis will start waning after that, and normal transactions will start rising.

What demonetisation has done in cities is shift large transactions from cash to cards or e-wallets, which means business may be shifting from kirana stores to big retailers. A Times of India report noted that a day after Prime Minister Narendra Modi announced demonetisation, PayTM, which normally sees customers adding Rs 1.5 crore every hour to their wallets, saw a 10-fold jump on Wednesday (9 November).

Kishore Biyani, who runs Big Bazaar and other big format stores, says his stores saw sales drop to 60-65 per cent of normal the day after demonetisation, but are now back to normal. This is likely to be the story at all big retailers, since money is not in short supply, only physical cash, for the middle and upper classes.

The actual shift to normality will happen when daily purchases revert to their old patterns at the small retailer level, with local kiranas and veggie vendors getting back their business, either through increased cash availability or by adopting digital payments options quickly in this crisis. One should hope it will be the latter.

We can hazard a guess that this should happen by the end of December, when cash will no longer be in short supply in most cities and bank lines start disappearing.

However, the pain in rural areas – where cash is the only means of business, especially in agriculture – will probably linger for another quarter. Farmers are desperately short of cash, and both banks and business correspondents will be pushing hard to make cash available for rabi season fertiliser and seed purchases, and for household purchases that will be boosted by good kharif earnings. The demonetisation challenge will thus essentially be a rural challenge after December. But then, agriculture is a small part of GDP, just about a sixth. It is the non-agriculture sector that is the key to growth. That part will revive faster.

If one takes all positive and negative signals together, the positives outweigh the negatives. Consider:

#1: Rates will fall. The consumer prices index is down to 4.2 per cent in October, a 14-month low. Thanks to demonetisation, 10-year bond yields are also down to around 6.5 per cent, which means banks are making huge gains in their treasury portfolios even while their cost of funds is coming down. The huge deposit inflows into banks will make it easier for banks to cut both deposit rates and lending rates, even if the Reserve Bank of India does not cut rates further in its December policy. K V Kamath, former chairman of ICICI Bank and now head of the New Development Bank (ie, the BRICS Bank), sees rates coming down by one per cent in the next six months. We are in a falling rate regime in the foreseeable future. This is just the right atmosphere for a revival.

#2: Markets will reverse. The sharp drop in stock markets, driven by uncertainties over demonetisation and possible drops in corporate profit expectations over the next two quarters, is understandable. But smart money should be thinking contrarian. When rates are going down, and if nothing fundamental has changed for companies in terms of consumer demand, the markets should be rising. Stocks and bank rates are inversely related. This means after the initial blip, the markets will make a recovery very quickly. The markets are spooked by long queues at banks, but once the cash fever abates, they will rebound sharply.

#3: The tax bonanza. Demonetisation is likely to push up government revenues in the short run, since cash is now coming into bank accounts and tax payments will probably go up. By 15 December, when the next round of advance taxes are to be paid, we will know how much Finance Minister Arun Jaitley is raking it in. And let’s not forget, tax revenues are already being bumped up by Rs 65,000 crore declared under the Income Declaration Scheme that closed on 30 September. Half the money to be paid in taxes this year (Rs 15,000 crore out of a possible Rs 30,000 crore). The rest will come by September 2017. The surge in tax revenues will help Jaitley to push public sector investment considerably.

#4: Equity infusions. If the market revives from January, assuming the demonetisation hiccups are over and investors start looking at what the next budget will bring (the 2017-18 budget will be presented on 1 February), more money will be raised from the capital markets and through public sector disinvestment. The chances are Jaitley will start cutting corporate tax rates in his next budget, a promise he failed to keep in his last budget.

#5: The election pick-me-up. Election season – major polls are due in Uttar Pradesh, Punjab, Goa and Uttarakhand – always brings a spurt in spending. The elimination of cash just months in advance of the polls is what is causing most of the angst in political parties. This will abate as new means of funding are discovered by the political class, and election spending revives in large parts of north India.

#6: Real estate question-mark. Demonetisation has damaged the real estate industry. But as cash becomes harder to get, more realtors may be forced to cut prices to spur sales, and rental yields could also rise for those already owning property. Realty prices also tend to fall in the run-up to major elections, as politicians – who are often benami owners of property – start cashing out to fund their campaigns. These two factors, if they start playing out in the next four months, when combined with falling interest rates, will spark some revival in property buying from the first quarter of 2017-18.

#7: Rising MSPs. The government has started raising minimum support prices (MSPs) for rabi, with wheat MSPs up by 6.6 per cent in the run-up to the Punjab and UP elections. Both states are big contributors to the food buffer. This will spur agriculture, even though it could stoke higher food inflation in the second half of 2017. But in the next two quarters, as kharif incomes come in, rural demand will start rising.

#8: Bank fortunes are improving. With the worst of the bad loans story now being put behind them. If profits surge and if Jaitley pumps more of his surging tax revenues into recapitalisation quickly, banks will resume lending to revive the investment cycle.

Whichever way one looks at it, the Indian economy seems on course for a V-shaped recovery in the first half of 2017-18. Narendra Modi has probably made the right call both economically and politically.

GVP

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