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Cash crunch led to 'material impact on spending', says Fitch

Wednesday, June 21, 2017

Demonetisation of old Rs 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 yesterday, warning that the ongoing steep decline in investment could spell risks to growth potential.

In its latest Global Economic Outlook (GEO), Fitch said Indian GDP growth slowed "significantly" to 6.1% in first quarter of 2017 from 7% in October-December.  This was the slowest pace since 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 – finally did have a material impact on spending," it said.

Stating that the lagged effect of demonetisation on the economy is "quite puzzling", Fitch said this partly reflects the challenges of measuring 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. "More worryingly, investment dipped into 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."

"We do, however, 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.

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