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Demonetisation to pull down India GDP growth rate to 6%: IMF

LiveMint logoLiveMint 22-02-2017 Asit Ranjan Mishra

New Delhi: India’s demonetisation drive may have a larger-than-anticipated negative impact on the economy in the near term through weaker private consumption, but will likely deliver positive benefits in the medium-term by curbing tax evasion, the International Monetary Fund (IMF) said on Wednesday.

IMF, in a report on so-called Article 4 consultation under which it holds annual discussions on policy matters with member-countries, said India’s economic growth is expected to slow to about 6% in the second half (October-March) of fiscal 2016-17, before gradually rebounding in the course of 2017-18. In the first half (April-September) of FY2016-17, the economy grew at 7.2%.

Prime Minister Narendra Modi on 8 November invalidated Rs500 and Rs1,000 currency notes, which made up 86% of the currency in circulation by value, as part of his government’s fight against black money.

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“The supply of new banknotes in the first month following the initiative was insufficient, even as the authorities took multiple steps to ease the currency transition,” the IMF said in its report.

The Fund in January cut its estimate of India’s economic growth by a percentage point in 2016-17 to 6.6% and by 40 basis points to 7.2% in 2017-18, blaming cash shortages resulting from demonetisation. One basis point is 0.01 percentage point.

In discussions with IMF representatives, Indian authorities agreed that “the replacement of specific banknotes could weigh on economic activity in cash-sensitive sectors in the short run,” the report said. But this effect would not extend beyond two quarters, and would be outweighed by the medium-term impact of a more efficient payments system and greater formalization of business activities, they said.

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IMF directors supported Indian efforts to clamp down on illicit financial flows, but noted the strains that have emerged from the currency exchange initiative. “They called for action to quickly restore the availability of cash to avoid further payment disruptions, and encouraged prudent monitoring of the potential side-effects of the initiative on financial stability and growth,” IMF said in the report.

The Fund’s directors also recommended continued vigilance to prevent domestic and external shocks, and urged India to advance economic and structural reforms in the labour market, land and power sectors to address supply bottlenecks, raise potential output, create jobs, and ensure inclusive growth.

“Continued progress in reforms bodes well for a marked improvement in medium-term prospects, with the adoption of the goods and services tax (GST) poised to raise India’s medium-term GDP growth to above 8%,” IMF said.

Risks to economic recovery include uncertainty in design and implementation of GST, and weak corporate and public bank balance sheets.

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