Editorial Notes

Editorial Notes 14th November 2016

Demonetization; Objectives of this Demonetization; Demonetization – A hard sell for the Govt; Assessment of the Economy; Positive Aspects of the Economy.
By IT's Editorial Notes Team
November 14, 2016


GS (M) Paper-3: “Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.”


Assessment of the Economy



We are now in the middle of the fiscal 2016-17. The main monsoon is also over. This is an appropriate time to take a look at the economy and assess where we are headed.

Two important questions that spring up are: are there green shoots which show a decisive revival of the economy, and have we laid the foundation for a faster rate of growth of the economy in the medium term?

Analysis of the Economy:

  • In analysing the trends in the economy, we continue to be plagued by conflicting sets of data.
  • National income data are available only for the first quarter (April-June). These data show that GDP grew by 7.1 per cent and that value added in manufacturing grew by 9.1 per cent.
  • However, according to the Index of Industrial Production (IIP) during this quarter, manufacturing fell by 0.6 per cent.
  • The Central Statistics Office (CSO) now uses IIP data for measuring only a small segment of manufacturing. It uses the corporate data for estimating 75 per cent of the manufacturing sector.
  • While one cannot fault the CSO for the new methodology, it has to carefully cross check the data it relies upon.

All the same, an attempt can be made to find out whether the current year will be better than the last year by looking at the performance of different segments.

Supply Side Perspective:

Looking at the problem from the supply side, the one segment that will do better is agriculture. This is based purely on the better performance of the monsoon.

Agricultural Production

  • In the short run, rainfall is an important factor influencing agricultural production.
  • The rainfall during the monsoon over the country as a whole was 97 per cent of the long period average (LPA). This is somewhat lower than what was originally predicted. But this is distinctly better than last year when the rainfall was only 86 per cent of LPA.
  • The Southwest Monsoon rainfall in the current year is approximately 13 per cent higher than last year.
  • Based on a study of the impact of rainfall on agricultural production, this should lead to an increase in value added in agricultural and allied activities by 2.7 per cent.

Demand side perspective:

From the demand side, there are four elements that we need to examine: private consumption expenditure, government expenditure particularly on investment, private investment particularly corporate investment, and external demand.

  1. Private Consumption Expenditure
  • As far as private consumption expenditure is concerned, a major factor contributing to a push is the implementation of the recommendations of the Seventh Pay Commission.
  • Government’s salary and pension expenditures are expected to rise by 20 per cent.
  • As those recommendations were made effective only from August 2016, the impact on the production of consumption goods will be seen only in the second half.
  • There is evidence of some sectors like two-wheelers growing fast. The impact of the good monsoon on rural demand may also show up in the second half.
  1. Government Expenditure
  • Total Central government expenditures in the first half were 52.0 per cent of the budgeted expenditures for the year. This is only a shade higher than previous year.
  • Capital expenditures have shown a rise of 4.6 per cent over the previous year. Increase in capital expenditures is welcome as they lead to greater investment.
  • In September 2016, capital expenditures grew by 20 per cent on year-on-year basis. However, this was mainly due to the increase in loans disbursed.
  • It is to be noted that the bulk of the public investment comes from public sector enterprises.
  • As of now, there is no information how much additional investment has been made by PSUs.
  • Roads and railways seem to be doing well.
  1. Corporate Investment
  • In the last several years corporate investment has been roughly one-third of the total Gross Fixed Capital Formation. Therefore it is critical to watch its behaviour.
  • In the September 2016 issue of RBI Bulletin, it has provided the outlook that emerges for 2016-17.
  • Bulk of the investment expenditures in any year are the result of the projects initiated in the previous two to three years.
  • With the slowdown in new projects undertaken in recent years, it is unlikely that investment expenditures by the corporate sector in 2016-17 can be higher than in 2015-16.
  • The study by RBI staff indicates that substantial investment in the projects initiated in 2016-17 will be required to equal previous year’s total investment expenditures.
  • The total cost of projects initiated with institutional assistance in 2015-16 was Rs.954 billion, and Rs.878 billion in 2014-15.
  • All this is a far cry from the figure of Rs.2,754 billion in 2006-07.
  1. External Demand
  • The external demand is largely a reflection of the world economy which shows a sluggish recovery. All forecasts indicate a slowing down in the world growth rate in 2016. The expectation is a slight improvement in 2017. World trade is also slowing. Exports of India started declining in 2015-16.
  • For the year as a whole, the decline was 15.5 per cent. Much of this was due to the fall in the value of oil exports.
  • However, some improvement in the current year is seen. The decline in exports during April-September was 1.26 per cent. This is on a base which had already declined.
  • In the month of September 2016, exports grew by 4.03 per cent. In an environment of declining world trade, it is not surprising that India’s exports fell.
  • However, data for 2015 showed that the India’s share in world exports has had a small decline, which indicates our exports are slowing down more than world exports.
  • India’s exports are doing a little better this year. We need to maintain this momentum.
  • India’s current account, however, has been comfortable because of the sharper decline in imports. The external environment may not provide much stimulus by way of demand.

Positive Aspects of the Economy:

  • Thus, the positive signs in the economy are an improved agricultural performance and a pick-up in rural demand, some increase in private consumption expenditure primarily due to the implementation of the Seventh Pay Commission recommendations and an enhanced capital expenditure by government.
  • The growth rate of GVA (gross value added) at basic prices in 2015-16 was 7.2 per cent.
  • This year it may be slightly better at 7.6 per cent mainly because of improved agricultural performance.
  • This estimate of the growth rate will undergo a downward revision if the disruptions caused by demonetisation persist for a long time.
  • The Indian economy has acquired a certain amount of stability.
  • Prices are under control. Both CPI (consumer price index) and WPI (wholesale price index) inflation are below 5 per cent.
  • Improved agricultural performance may further moderate food prices.
  • The fiscal picture has been under control, even though as of now the fiscal deficit is running high.
  • The current account deficit remains subdued. For the current year, it may be lower than last year’s level of 1.1 per cent of GDP.
  • All these are favourable factors for sustained economic growth. The banking system is however under stress.

On the reforms front, there has been some improvement.

  • Initially, there was the amendment to the Insurance Act to facilitate larger foreign investment.
  • The Bankruptcy Act has been enacted.
  • The real estate sector now has a regulator.
  • Finally, the goods and services tax is becoming a reality. All of these are enabling legislations.

The impact of these legislations on the economy will take some time to come. But they are moves in the right direction.


There is continued stagnation in corporate investment and a poor external environment. To maintain a high growth rate in the medium term, a kick start in investment is imperative. This is yet to happen, even though the investment sentiment is slightly better today.

But more than ever, non-economic factors will play a key role determining if this sentiment will be sustained or not. Policy-makers need to be conscious of this and keep the focus on growth, and away from divisive and disruptive issues.

[Ref: The Hindu]


GS (M) Paper-3: “money-laundering and its prevention”
GS (M) Paper-3: “Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.”
GS (M) Paper-3: “Inclusive growth and issues arising from it.”
GS (M) Paper-2: “Government policies and interventions for development in various sectors and issues arising out of their design and implementation.”


Demonetization successful only if results in Fiscal Gain


Objectives of this Demonetization:

  • Nullification of black money hoarded in cash
  • Tackling of counterfeiting Indian currency notes
  • Curbing of terror financing with fake currency notes

Demonetization – A hard sell for the Govt- Why?

  • Any decision to withdraw the legal tender status of currency in circulation creates a sense of confusion and some despair.
  • Only a few among the population have a clear idea of how demonetization could deliver the intended outcomes.
  • Its economic costs & benefits are hard to assess based only on forecast.
  • Achieving economic and political goals with normal policy measures seems difficult at times. 

Currency management:

  • Currency management is one of the RBI’s less glamorous functions that does not attract public attention except in times such as this.
  • A certain section of the population that lives outside the banking system will be affected the most.
  • Fall in demand, especially in retail sectors is expected in short run.
  • But the RBI has planned reasonably well to use its own offices/branches as well as about 1,34,000 branches of banks in the country to collect the demonetized notes and supply new currency notes, including notes of a new series of ₹500 and ₹2,000 denomination to minimize disruption in the economic and social lives of people.

Comparison with last demonetization:

  • It is not realistic to compare both in terms of economic impact and scale of the logistics involved.
  • Demonetizing high-denomination notes — ₹1,000, ₹5,000 and ₹10,000, also known as registered notes — in 1978, was a tame and a largely inconsequential affair. These three denominations together accounted for less than 10 per cent of the value of the notes in circulation then.
  • The exercise redeemed close to 95 per cent of the value of these notes in circulation, thereby generating negligible fiscal gain.
  • Whereas now the ₹5oo and ₹ 1000 notes account for more than 80% of the notes circulated.
  • And the impact of this demonetization can be seen in all classes especially those in the lower pyramid.

Where cash rules:

  • India is a cash-dependent economy.
  • Its cash to GDP ratio at 11% is much higher than in most economies.
  • Close to 98% of all consumer payments are made in cash.
  • Financial technology companies in the payment services sector are upbeat that demonetization will also mean a big digital push for India.
  • Some of them have even seen a spurt in business in the wake of the demonetization announcement.
  • This is seen against the setting up of the Unified Payment Interface (UPI) in August this year and the reported plans of the Government to prohibit cash transactions involving ₹500,000 or more.
  • There are reasons to be hopeful that India will bring lower dependency on cash over the next five years.

Yardstick-Fiscal Gain:

  • The fiscal gain accruing to the RBI and to the govt will be success of this demonetization exercise.
  • According to the latest RBI data (end-March, 2016), the notes of ₹500 and ₹1,000 denomination together constitute, in value terms, 4% of the total notes in circulation.
  • Their aggregate value is ₹14,180 billion (₹14,180 crore).
  • Over the last few years, the annual growth rates of the circulation of notes of these two denominations have largely tracked the growth rate of nominal GDP, indicating no sudden spurt in their demand.
  • The size of the black economy in India is estimated to be in the 20-25 per cent range.
  • It is safe to assume that the structure of the black economy, including that of its ‘cash component’, has been fairly stable over the years.
  • This leads another safe assumption that the proportion of black cash in the aggregate currency in circulation is also around 25 per cent. In fact, it should be higher than 25 per cent, given the higher preference for cash in the case of tax-evaders vis-à-vis others.

Measuring success:

  • The demonetization will be a success if the fiscal gain is at least 25% of the value of the ₹500 and ₹1000 notes in circulation, that is, ₹3,545 billion, equivalent to about $53 billion.
  • The fiscal gain is the sum of the value of the ₹500 and ₹1000 notes that will not be tendered for exchange or for credit to bank accounts plus the penalty that tax-collectors will levy on those with mismatch between the notes deposited and their respective declared incomes.

Way forward:

  • It is clear that that a good bit of planning and preparation involving the ministry of finance and the Reserve Bank of India were completed beforehand and that it was done in absolute secrecy is no small feat.
  • A few commentators and analysts have opined that this will engender a marked fall in the use of cash transactions in India and thus pave the way for the transition to a ‘cashless’ economy.
[Ref: Business Standard]
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