Today’s picture is
not pretty: government needs to push up spending quickly and sizably to make up
for a possible drop in the rest of the economy. This will ensure India's expected growth path is not disrupted in the short term.
Good buying
opportunities for long term investors in the coming months in Indian stocks can
be expected.
The demonetisation of Rs. 500 and Rs. 1000 rupee notes, which
came into effect two weeks ago, is good for the economy and people in the long
term, most Indians will agree. However, it can be argued that the
implementation of this move has not been executed well.
Reports daily appear in the press and social media of the
difficulties faced by people and businesses – both small and large – in
conducting their daily activities both in large and small towns and across
sectors.
I went yesterday to two ATM machines next to my residence,
and found they dispensed only the new high value Rs. 2000 notes – which are not
generally accepted at most shops for daily payments. A friend in Mumbai
reported to me that she went to her bank – India’s leading private sector bank
- to withdraw money, but was told that she could not withdraw money.
Rs. 500 and Rs. 1000 notes account for 85% of currency in
circulation, and cash accounts for 11% of GDP in India. New notes on this
massive scale need to be produced, distributed and stored in newly calibrated
ATMs across India. The informal economy accounts for 40% of India’s
economy, and mainly runs on cash.
Witnessing the execution of the demonetisation move, my own,
clearly subjective, view is that it will take six months for cash to lubricate
without friction the economy just as it did before.
I have created a picture (model) of the growth of India’s
economy over FY16-17, and presented three subjective scenarios below.
Scenario 1
Informal economy shows zero growth in Q3 after
demonetisation, but returns to its normal path in Q4 – The formal economy grows
at 6.6% at a slower pace in Q3 after demonetisation and then returns to the
normal growth path in Q4.
Net result: India’s economy grows by about 7% in 2016-17 –
about 0.5% lower than expected.
Scenario 2
Informal economy shows negative growth of 5% in Q3 after
demonetisation - and why not given all that I see and read in the papers - and
recovers enough so that there is no fall in output in Q4 – The formal economy
grows at 6.6% at a slower pace in Q3 after demonetisation, and then returns to
the normal growth path in Q4.
Net result: India’s economy grows by about 6% in 2016-17 –
about 1.5% lower than expected!
Scenario 3
Informal economy shows after demonetisation negative growth
of 10% in Q3 and recovers enough so that there is no fall in output in Q4. The
formal economy grows in Q3 at 6.6% at a slower pace after demonetisation, and then
recovers, though not completely by rising to 7.2%, in Q4.
Net result: India’s economy grows by about 5.5% in 2016-17 –
about 2% lower than expected!!
In this uncertain scenario, the 10% fall in India’s stock
markets does not seem to be enough. Note this comes at a time when following a
Trump victory in the USA interest rates are increasing – seen by many as just
the beginning of a rising interest rate cycle. It looks like there will be good
buying opportunities for long term investors in the coming months in Indian
stocks.
My own view is that government needs to act fast and sizably
to pump money into the economy – if that means a higher fiscal deficit then so
be it. Government has already announced measures for the rural sector in the
last week. RBI has asked banks to effectively extend the repayment period for
loans by small businesses.
