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In 2016, India retained its position as the seventh largest economy globally in US$ terms, with an annual real GDP growth rate of 7.1%, the highest amongst G20 nations. This has been brought about by government efforts to enhance investor appeal, as well as dwindling oil prices that lowered the imports bill. Reforms, such as the demonetisation drive in November 2016, are part of a larger portfolio of changes. Reforms under Mr Modi’s administration will lead to a rise in foreign investment, jobs growth, and consumer spending, provided that they are implemented effectively.
The Reserve Bank of India (RBI), the country’s central bank, has adopted an inflation target of 4.0% (+/-2.0%) from August 2016 until March 2021. Inflation decelerated from 5.3% in the third quarter of 2016 to 2.7% in the fourth quarter 2016, by the demonetisation of INR500 and INR1,000 notes on 8th November 2016, which was executed to fight corruption and black money;
Demonetisation came as an economic shock to a country with a relatively large informal sector and, therefore, heavily dependent on cash. Euromonitor International expects the negative effects of demonetisation to last until the second quarter of 2017. Given the government’s large infrastructural plans and continued focus on increasing the living standard of the rural populace, year-on-year real GDP growth is expected to reach 8.9% by the first quarter of 2018.
India’s Quarterly Real GDP Growth and Business Confidence Index: Q1 2013 – Q1 2018
Source: Euromonitor International from national statistics /UN/OECD/IMF (WOE)
Note: (1) Data for Q1 2017-Q1 2018 are forecasts
(2) The standardised business confidence index is calculated for cross-country comparability, indicating the number of standard deviations each observation is above or below the long-term mean. The further the index is from zero the better/worse the confidence is compared to the long-term average
(3) Quarterly real GDP growth data is % growth over same period of previous year and non-seasonally adjusted
Demonetisation will shrink the informal sector
Demonetisation will yield positive results in the long-run, provided that the government monitors cash flows and promotes digital payments:
As the short-lived economic crunch effects of demonetisation dissipate, India’s annual real GDP growth rate will rise from 7.1% in 2016 to 7.4% in 2017 (the highest amongst major economies);
According to trade sources, the informal sector employed nearly 75.0% of the workforce as of 2011-12 (latest data available). Those working in the informal sector, who are mostly reliant on untraceable cash transactions and often evading taxes, were forced to find alternative methods requiring them to declare their cash-related assets. This will increase tax revenue, which can be used for infrastructural or other government investments;
Unprecedented growth in digital finance, as an alternative to cash, is leading to a larger market share for financial entities;
A surge in cash deposits has left banks with more money to lend. This could induce banks to cut lending rates, kick-starting stagnant credit growth and boosting investment.
Demonetisation is one part of several Modi-led reforms
The government is focusing on enhancing overall competitiveness and financial inclusiveness:
According to Euromonitor Consumer Finance, the percentage of the unbanked population (aged 15+) more than halved from 17.9% in 2013 to 8.1% in 2016, thanks to the ‘Pradhan Mantri Jan Dhan Yojana’ scheme that was launched in August 2014. According to government sources, the programme has helped open up 28.6 crore (286 million) bank accounts;
In April 2015, the Micro Units Development and Refinance Agency (MUDRA) Bank was launched, which took charge of financing and monitoring the microfinance institutes that offer loans to small/micro businesses. This will reduce the cost of obtaining credit for small/micro businesses;
In May 2016, India passed the new Insolvency and Bankruptcy Code 2016, which will make it far easier to resolve insolvency, thereby improving the business environment;
In June 2016, the government approved 100% foreign direct investment (FDI) in prime sectors, including civil aviation, increasing the scope for FDI;
Furthermore, one of the most eagerly-awaited reforms of the decade, the Goods and Services Tax (GST), is finally set to happen in July 2017. Apart from substantial reduction in time and cost linked with paying taxes, it will simplify India’s complex tax structure by substituting a host of different taxes in different states by one unified tax.
India’s economic appeal lies in effective implementation of reforms
India’s macroeconomic potential has improved, but some challenges still persist:
The delays in the execution of the GST highlight the need for faster and more effective implementation of reforms. India suffers from one of the highest regulatory burdens regionally;
Owing to lack of reforms towards increasing the efficiency of public-sector banks, India’s nonperforming loans (NPLs) surged over 2011-2016, placing it as the highest amongst major economies in the region. This has hampered banks’ lending capacity, stagnating credit growth;
The world’s major developed economies are currently undergoing a policy shift towards protectionism, which might slow the pace of global trade and immigration, of which India has been one of the major beneficiaries.
India’s Bank Nonperforming Loans to Total Gross Loans: 2011 and 2016