Demonetization: Gearing up for Policy Response

Impact on GDP growth of Government's recent Demonetization move: India's Revised GDP estimates for FY17 and FY18 have been published by at-least two Institutions and a similar exercise is on with feverish pace at most Banks, Rating agencies, Brokerages and Research think tanks. The revisions are not flattering and the first such published study estimates FY17 GDP growth figures lower by 3.3% and by 1.5% in FY18(as compared to the previous GDP growth estimates prior to the demonetization). Another study pegs the estimated growth lower by 03-0.5% in FY17. While economists and think-tanks crunch the revised GDP numbers as above, we are also interested in the consequent impact on Inflation due to the estimated shock to growth. At the current CPI(October'16) rate of 4.20% , the estimates for CPI rates at the end of FY 17 and FY 18 for the various GDP shock scenarios are provided below:

So we are staring at CPI rate scenarios ranging from 0.8% on the lower side to 3.6% on the upper side. While the upper side scenario is not a great concern, the lower end scenarios do not augur too well and call for concerted fiscal and monetary resuscitation to get economic growth back in shape. The Government(for the fiscal response), RBI and the Monetary Policy Committee(for the monetary response) must dispassionately examine the impact on economic growth and prepare for the most likely scenario that is likely to evolve in its best judgement. We shall not delve here into other relevant factors such as the external macro environment viz. Brexit, new US Administration and the like, but the range of estimates clearly indicates that for scenarios (a.) and (b.) above urgent fiscal and monetary action would be required. It is recognized that authorities have ample space to act in both areas. It must be then be utilized to the fullest and at the correct time, even preemptively if the scenarios (a) and (b) materialize/are most likely to materialize. Offcourse, a CPI print below 2% will trigger the framework between RBI and the Central Government which clearly says that CPI rate target is the range between 2% on the lower side and 6% on the higher side and must not be allowed to breach either. The necessity for fiscal and monetary resuscitation is made all the more urgent given the forecast of sharp drop in Credit in the above scenarios:

So clearly, in the scenarios (a) and (b) strong fiscal and monetary medicine would be urgently required. We did not have control on either the rollout or the implementation of the demonetization. But we must be prepared to respond to all the probable implications to this step in the near future to maintain strong economic growth.