The country’s GDP growth rate for the current financial year is set to slow to 6% on account of demonetisation and is expected to maintain the same rate for five years, according to the Centre for Monitoring Indian Economy (CMIE).

“Before the demonetisation shock, the Indian economy was expected to gradually accelerate its real GDP growth rate from 7.5% to over 8% per annum,” Mahesh Vyas, Managing Director at CMIE wrote in an article. “We now expect this growth trajectory to shift down to about 6% per annum for the next five years. The economy is unlikely to achieve a growth of 7% any time during the coming five years.”

The removal of 86% of the currency in circulation led to a sharp decline in private consumption expenditure, Mr.Vyas stated.

“The fall in retail inflation to 3.6% in November and the fall in sales reported by several fast-moving consumer goods companies are early indications of the fall in consumption expenditure,” he wrote.

“The immediate impact of demonetisation was a sharp reduction in private final consumption expenditure, a corresponding fall in retail prices of perishable commodities, a substantive dislocation of labour and corresponding losses in wages and break-down of supply chains in many parts,” he stated.

The dislocation of labour, due to workers having to waste productive time standing in a line at banks, and further losing out on wages because employers themselves did not have the cash to pay them, further dampened consumption expenditure.

“We expect this low demand to persist till three conditions are met,” Mr. Vyas wrote.

“First, liquidity is fully restored; secondly, confidence in liquidity is fully restored; and thirdly, consumers are yanked out of their equilibrium at lower levels of consumption of non-essential commodities.”

None of these conditions, he added, is likely to be fulfilled anytime soon since the restoration of full liquidity is estimated to take as long as till September, and the public will take even longer to regain confidence in the government and the Reserve Bank of India.

Consumer spending hit

“As a result, we expect the hit on consumer spending to last much longer than just a few quarters,” Mr. Vyas wrote.

“Private final consumption expenditure (PFCE) grew 7.5% in 2015-16. We had expected PFCE growth to accelerate to 7.8% in 2016-17 and then to over 8% going forward. Now, we have scaled back the PFCE growth estimate to 5.5% for 2016-17 and to 6.8 % per annum going forward.”

Mr. Vyas further expected this downward trend in consumption expenditure to delay any revival in private sector investment.

“We expect capital formation to shrink by nearly 2% in 2016-17 as against an earlier expectation of a 2.3% increase in the same,” Mr. Vyas wrote. “ We had expected investments to pick up pace each year thereafter to reach 10 % growth only in 2020-21. Gross fixed capital formation was expected to remain around 29 % and reach 30 % of GDP only in 2020-21. Now, we believe that the investments-to-GDP ratio would be only around 27-28 %.”

“We expect government spending to offset part of the impact of demonetisation through increased spending,” Mr Vyas added. “But, government has a smaller role and can contain the damage only partially.”