Indian Economy Outlook for 2017 Could Suffer Effects of Demonetization
Analysts should downgrade their Indian economic outlook for 2017. A risky government maneuver could cause India’s economic growth rate to lose the momentum of the past few years. Indian Prime Minister Narendra Modi’s plan to curb corruption has, more than anything else, put the brakes on gross domestic product (GDP) growth.
Unlike so many recent developments, the India economic growth rate slowdown has nothing to do with U.S. President Donald Trump. The slowdown doesn’t even have a specific relation to the global economy growth. Rather, Narendra Modi has decided to, literally, cut the supply of rupees. Overnight, last November, the Indian government withdrew several bills from circulation.
In so doing, Prime Minister Modi has hurt the Indian economy outlook for 2017. Modi’s dream to see a higher India economic growth rate than China’s vanished just as India’s main banknotes did last November. Indeed, the IMF lowered the Indian economy outlook for 2017 by a full percentage point.
Fiscal 2016/2017, which ends on March 31, 2017, will show a GDP growth of 6.6% rather than 7.6%, said the International Monetary Fund (IMF). Meanwhile, Chinese GDP will increase by 6.7% over the same period. The demonetization of the 500-rupee and 1,000-rupee bills will see India losing its position as leader in global economy growth.
India earned this lofty spot for the first time last year. The demonetization, however, has caused a monetary shock because it wiped out, in a single stroke, 86% of banknotes in circulation. Modi said the move would target the black-market economy and corruption. But India still does so much business in cash that no sector was left untouched.
India Is Losing its GDP Crown
Cash volatility caused household consumption to plummet, literally overnight. India’s economy has slowed down thanks to the self-inflicted wound of demonetization. Sales have plummeted in virtually every industry, but the most affected sectors were jewelry and construction.
Paradoxically, in India, industry has been the priority of five-year economic plans since independence. Economic development has risen but, more recently, industrial growth (as in manufacturing), after rising for years, has stabilized at a lower percentage than in other emerging economies of similar income levels. The relative weakness of the manufacturing sector is of concern to India.
In fact, the rapid urbanization—which demonetization will increase as the government targets the informal economy—is a concern. As the middle class expands in India, it will demand more manufactured goods. Many of these goods, from cars to appliances, would have to be imported. The result could well be a massive trade deficit.
India has grown by 7.3% in the quarter that ended in September 2016; that is, before the demonetization. But the effects of the ban are still evolving; it’s possible that India’s economic slowdown could be greater, especially in the short term. But the risk exists that the effects could linger well into the next few years, compromising previous GDP growth estimates of 7.2% in 2017 and 7.7% in 2018.
A Sign of Optimism Ahead?
To that effect, there is a glimmer of optimism on the horizon. Prime Minister Modi has promised more government spending and lower taxes for small and medium enterprises (SME) and low incomes. In other words, the very sectors of the economy most affected by the demonetization. Modi has a political incentive.
He made the promises on the eve of important elections in five states of the Indian federation. It remains to be seen whether Modi can keep those promises. For Modi to achieve the tax cuts and, presumably, sustain the growth momentum, the demonetization will have to start to produce its intended effects.
The goal was to prevent tax evasion and the dissemination of false banknotes, which has been a significant problem in India. The rupee has become one of the most falsified currencies in the world. But if the policy results in more people paying taxes—as opposed to some people paying more tax—the Indian government might achieve its goal of resuming (and winning) the GDP growth rate race with China.
The most recent budget, presented on February 8, 2017 by Finance Minister Arun Jaitley, provides almost 25% more funds for rural areas. The intention is to alleviate poverty and improve infrastructure. SMEs (those companies with revenues up to $7.4 million), which account for 96% of Indian businesses, will benefit from a reduced tax rate of 30%-25%.
Lower income taxpayers will also get a break. Those earning incomes that are the equivalent of between $3,700.00 and $7,400.00—that is, between INR250,000 and five lakhs (one lakh equals INR100,000.00)—the rate is halved to five percent. Top earners will face a surtax of 10%. Overall, the cuts on direct taxes are worth $3.0 billion, and government spending rises by 6.6%. (Source: “How does Arun Jaitley’s budget impact my take-home salary?,” Quartz, February 3, 2017.)
Ambitious GDP Goals Have Not Vanished
Meanwhile, the Indian government has kept ambitious goals. To achieve the desired GDP growth goals, it has planned a privatization of over $10.0 billion worth of assets. To combat its notorious poverty, India has considered giving some citizens a cash handout, as a form of basic income. (Source: “India considers cash handouts to fight poverty,” RT, February 6, 2017.)
The finance minister has also found just $1.5 billion to be pumped on the balance sheets to help deal with a vast array of bad loans. This would be a good time to note that many of the world’s poorest people live in India.
Finally, New Delhi wants to crack down on political party financing, which relies too much on anonymous donations to cover election expenses in the largest democracy in the world (and among the most affected by corruption and cronyism).
Political parties, from now on, will have to declare their income and may not accept donations in cash in excess of 2,0000 rupees ($30.00), from the current 20,000 rupees. (Source: “India’s New ‘Electoral Bonds’ Aim to Clean Up Campaign Financing,” Bloomberg, February 2, 2017.)
Many of these measures have been evidently launched to win votes at the polls in state elections. Some, as in the states of Punjab and Goa, have already opened. The results will be seen as a test for Modi. Should his BJP Party win in key states such as Uttar Pradesh, Modi will have a clear path ahead.
If not, even the revised and lower GDP estimates for 2017 might be revised downward. Narendra Modi must win key battles in order to shift the balance of the upper house of parliament in his favor. If he can get a majority, he will be able to push through the legislation he intends to use to achieve faster and higher economic growth.
Uttar Pradesh, the most populous state in India, with over 75 million people engaged in agriculture and 155 million people living in rural villages, is the key. Thus, the big question is no longer whether 2017 will be India’s big year. Modi himself appears to have given up on that. Rather, the question is: can India resume its seven-percent-plus economy growth rate in 2018?
Economists, analysts and optimists have long expected that India, the world’s second-largest country by population after China, would overtake the Dragon from the business point of view. There’s no question India will remain one of the brightest stars of global economy growth despite the demonetization.
Car Sales Are a Key Factor
As in China, one of the most significant indicators of growth is personal mobility. In other words: how many cars are being sold in India? The forecasts have not always been right. Indian GDP has grown at a higher rate than China in 2015, in 2016, and even in 2017. China recently admitted that its GDP, for the first time in years, would not exceed 6.5% for 2017.
Still, the Chinese economy remains five times larger than that of India. But, car sales are seven times higher than India. Note, India has already surpassed China where automobile exports are concerned. It exported over 523,000 vehicles in FY2016. (Source: “India surpasses China in passenger car exports,” Autocar Professional, June 7, 2016.)
However, China is the world’s largest car market now. It’s seven times larger than India’s. (Source: “Analysis of World’s Biggest Car Market – China,” Auto Punditz, March 13, 2016.)
It will take at least a decade before India even catches up. Late last year, India registered just over three million cars. It’s twice as many as in 2007, but still nothing compared to the size of the market, given its population of over 1.3 billion people.
Not even the “Tata Nano,” a microcar that can seat four people at a cost of about $1,700.00, has been able to propel overall car sales in 2016. The Tata Nano has never taken off. India 2017, just 70 years after independence, is still a country with deep contradictions. The reforms of the Narendra Modi government could spur a gear change.
The car market has been rising at about the same pace of GDP, or above seven percent. Among foreign brands, Renault SA (EPA:RNO) is strongest. Local brand Maruti Suzuki India Limited (NSE:MARUTI, BOM:532500) is the market leader, followed by Hyundai Motor Co (OTCMKTS:HYMLF, HYMTF), and even the Indian company Mahindra (NSE:M&M, LON:MHID). But, the demonetization might cause the market to dip.
After all, while there is class mobility in India, the rich are constantly increasing, and the middle class has come under pressure. Thus, luxury car manufacturers operating in the country are doing relatively well. They won’t see the impact that the Maruti and lower-end Mahindra motors will experience.