Nomura, for instance, believes there is a downside risk to its Q1 GDP growth projection of 6.9% y-o-y. (Source: Reuters)

With consumption spends in rural and urban India stifled by the acute scarcity of cash, the economy is set to clock sharply lower levels of growth in the current and coming quarters. While the initial days of demonetisation saw economists merely pruning their growth estimates, the cuts could get bigger.

Nomura, for instance, believes there is a downside risk to its Q1 GDP growth projection of 6.9% y-o-y. “Near-term growth may fall much more than expected,” economists at the brokerage wrote. They alluded to proprietary indicators which had slumped to their lowest level since the series started in 1996 and were consistent with a below 6% GDP growth.

While sales have decelerated across markets, given the larger volume of cash transactions, the hinterland has been hurt far more than urban areas.

Economists at Bank of America Merrill Lynch (BofAML) estimate every month of disruption due to demonetisation costs between 0.3- 0.5% of GDP. Consequently, they are now looking at a FY17 GDP growth target of just 6.9% rather than the 7.7%. At a time when consumption was driving the economy in the absence of investments, the hit to sales of big-ticket items—property, jewellery, cars and other durables—will deal a blow to the economy.

Credit Suisse has reworked its forecast for GDP growth in FY17 to 6.9% from a more robust 7.8% since it feels consumption will grow at a much slower 6.5%, way below the 8.2% anticipated before demonetisation.

“Businesses, especially small- and medium-sized enterprises, and sectors like automobiles and non-bank finance companies will probably see temporary disruptions as well,” the brokerage wrote.

High frequency indicators show the economy has been sluggish (see charts) — the contraction in railway freight together with slowing sales of commercial vehicles is a sign of weak demand. While consumer goods sales had started picking up after the raises for government employees, demonetisation will put the brakes on consumption for the next few months. In the meanwhile, investment continues to be anaemic; gross fixed capital formation (GFCF) contracted for the third straight quarter in Q2FY17 after increasing by sub-1% in Q3FY16.

Consequently, corporate earnings could continue to disappoint; Bofa ML estimates a downside risk of anywhere between 1-6% to its FY17 earnings estimates. To be sure, the recovery reflected in the Q2FY17 results may seem impressive, analysts point out these came off a low base. More pertinently, underlying trends — volumes for instance — have been subdued. BofA points out that Q2FY17 aggregate numbers are somewhat misleading because of the 70 sub-sectors that it tracks, the fewest number at 61% have delivered a growth in earnings before interest and tax (ebit).

“Demonetisation plus GST mean earnings will be volatile for the next 3-4 quarters,” the brokerage wrote recently, adding further downgrades were possible. “Demonetisation measures will not help,” Kotak Institutional Equities (KIE) wrote in a recent report. The brokerage, nevertheless, expects earnings to grow 13% and 20% in FY17 and FY18, respectively. That’s on the back of profits in sectors such as PSU banks, metals & mining and pharmaceuticals getting normalised.

The brokerage cautions that there are potential risks to earnings in sectors such as cement, consumer discretionary and industrials on the back of weaker-than-expected demand and profitability. “Weakness in demand will also hurt profitability disproportionately,” KIE noted.