Cash crunch led to ‘material impact on spending’, says Fitch

Fitch said the recovery in global growth is strengthening and is expected to pick up

 

Demonetisation of old ₹500 and 1,000 notes had a “material impact on spending” as reflected in significant slowing of GDP growth in January-March, Fitch Ratings said on Tuesday, warning that the ongoing steep decline in investment could spell risks to growth potential.

In its latest Global Economic Outlook (GEO), Fitch ha said that the Indian GDP growth has slowed “significantly” to 6.1 % in first quarter of 2017 from 7 % in October-December.

This was the slowest pace since the fourth quarter of 2013-14.

“Domestic demand accounted for the bulk of the slowdown.

It appears that the cash squeeze of November 2016- whereby the government pulled 86 % of cash in circulation out of the economy virtually overnight - did have a material impact on spending,” it said.

Stating that the lagged effect of demonetisation on the economy is “quite puzzling”, Fitch has said that this partly reflects the challenges of measured spending in an economy with a large informal sector.

Consumption growth fell substantially to 7.3 %, from 11.3 % in the fourth quarter of 2015-16.

“ Investment dipped into the negative territory (-2.1 %). This partly reflected poor construction activity, which fell by 3.7 %, an unprecedentedly low level in recent years,” it said, adding that this may have been affected by the demonetisation shock.

Stating that investment has been persistently weak in recent years, Fitch said investment as a share of GDP has been trending down for several years and “ongoing steep declines could spell risks for medium-to-long term growth potential.”

“ However we expect investment to gradually pick up from current lows on the back of the transmission of supportive monetary policy of the past two years and stepped up structural reforms,” the rating agency said.

Fitch expected that the goods and services tax (GST), which is to kick in from July, will facilitate trade within India and reduce transaction costs.

Also, public spending on infrastructure is set to rise, boosting investment. “This should help drive a pick—up in GDP growth, which we forecast at 7.4—7.6 % in the next two fiscal years,” it said.

CPI inflation should also tick up as the current low food price effect will fade, but would remain firmly within the central bank’s target range, it said

Fitch said the recovery in global growth is strengthening and is expected to pick up to 2.9 % this year and peak to 3.1 % in 2018, the highest such rate since 2010.

“Faster growth this year reflects a synchronised improvement across both advanced and emerging market economies. Macro policies and tightening labour markets are supporting demand growth in advanced countries, while the turnaround in China’s housing market since 2015 and the recovery in commodity prices from early 2016 have fuelled a rebound in emerging market demand,” said Brian Coulton, Fitch’s Chief Economist.