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According to official statistics, demonetisation hardly dented economic momentum. India’s GDP growth slowed only marginally to 7% y-o-y in Q4 from 7.4% in Q3, above expectations (6%). Private consumption, fixed
investment and industrial output growth all accelerated in Q4, with only the services sector witnessing a slowdown.
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This does not add up. High frequency real activity data released since demonetisation suggest that consumption and services were hit after demonetisation because they are more cash-intensive.
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We believe there could be three reasons for this discrepancy: (1) the inability of official statistics to capture the negative growth effects on the unorganised sectors; (2) positive base effects created by the
0.8pp upward revision in Q4 2015 GDP growth; and (3) companies may have showed their cash in hand as sales. In our view, official GDP statistics are significantly underestimating the growth impact of demonetisation.
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For FY17, the government estimates GDP growth to slow to 7.1% y-o-y versus 7.9% in FY16, which implies Q1 2017 growth of ~7.0-7.4%. We believe this is too optimistic because while activity has improved in January,
it remains below pre-demonetisation levels. We expect the slowdown to spill over into Q1 with GDP growth slowing to 6.7% (revised up from 5.7%). We are revising up our 2017 GDP growth forecast to 7% vs. 6.9% earlier on account of faster Q1 growth.
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Beyond Q1, we are optimistic. Ongoing remonetisation, benefits from demonetisation (lower lending rates and fiscal gains) and pay hikes for state government employees should result in growth recovering to 6.8% in
Q2 and an average of 7.5% in H2 2017.
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On the policy front, as remonetisation progresses, some of the disinflationary effects of demonetisation should also start to fade. With inflation set to rise, we expect the Reserve Bank of India (RBI) to stay on
hold throughout 2017.
Official stats suggest not much growth impact after demonetisation
According to official statistics, demonetisation hardly dented economic momentum. India’s GDP growth slowed only marginally to 7% y-o-y in Q4 from 7.4% in Q3, sharply above expectations (Consensus and
Nomura: 6.0%). GVA growth moderated by 10bp to 6.6% from 6.7% in Q3, also above expectations (Consensus and Nomura: 6%; see Figure 1).
Possible reasons for the upside surprise
We believe there could be three reasons for the upside surprise: (1) the inability of official statistics to capture the negative growth effects on the unorganised sectors, as the official numbers are
based largely on organised sector data; (2) the GDP growth estimate for Q4 2015 was also revised lower by 0.8 percentage points (pp) to 6.5% y-o-y from 7.2%, thereby creating a large favourable base effect for comparison; and (3) if companies showed their
cash in hand (after demonetisation) as sales, then this may be getting captured as a higher value addition in these specific sectors (as corporate data are partly used to estimate growth). In our view, official GDP statistics are significantly underestimating
the growth impact of demonetisation.
Private consumption and investment accelerate … surprisingly
On the demand side, private consumption growth accelerated to 10.1% y-o-y in Q4 vs. 5.1% in Q3, suggesting despite less cash availability, consumers continued their buying spree. Government consumption
growth also rose sharply (19.9% y-o-y in Q4). Fixed investment growth, which was weak prior to demonetisation, moved into positive territory after the cash ban (3.5% vs. -5.3%). Both export and import volume growth also improved in Q4, but with imports rising
faster than exports, the contribution of net exports fell sharply to -0.3 percentage points (pp) in Q4 vs. +1.6pp in Q3.
Services slow, industry accelerates
On the supply side, higher winter crop production boosted agriculture GVA growth to the highest in the new GDP series at 6% y-o-y in Q4 versus 3.8% in Q3, while non-agriculture GVA growth slowed marginally
to 6.7% from 7.1%. The hit from demonetisation was felt only in the services sector, where GVA growth moderated to 6.3% from 7.6%, which is not surprising given a higher share of the unorganised sector within services. In particular, construction and financial,
real estate and professional services witnessed a sharp slowdown, while GVA growth in trade, hotels and transport in the service sector picked up, which is surprising in view of anecdotal evidence of a sharp hit to the trade and transport sectors. Finally,
industrial GVA growth accelerated sharply to 8% from 5.6%, as mining, manufacturing and utilities GVA growth gained momentum.
India’s growth statistics: fact or fiction?
Overall, the GDP data suggest that demonetisation hardly influenced growth momentum, with consumption demand accelerating in the quarter, when 86% of the currency in circulation was withdrawn. This does
not add up.
High frequency real activity data released since demonetisation suggest that consumption and services were hit after demonetisation, while the manufacturing and industrial sectors were relatively unharmed.
In fact, the cash-dependent rural economy witnessed a slowdown in consumption demand and discretionary consumption was also postponed. Hence, the implications from the official GDP statistics that demand in the cash-intensive sectors (private consumption,
transportation) picked up after demonetisation appears to be at odds with the reality.
As we mentioned above, the fact that the quarterly GDP statistics rely on organised sector data as a proxy for the unorganised sector may be the one of the reasons for the divergence, as the organised
sector was either unharmed or benefited from the shift in demand from the cash-intensive organised sector. Hence, the headline growth significantly masks the underlying slowdown.
The discrepancy between the official GDP statistics (robust) and ground-level data (weak) has been a concern ever since the start of the new GDP series. The gap has become even more glaring in the aftermath
of demonetisation.
We still expect a slower Q1, but we are revising up our 2017 growth forecast
For FY17 (year ending March 2017), the second advance estimate suggests GDP growth will slow to 7.1% y-o-y versus 7.9% in FY16, implying that growth in Q1 2017 is likely to be ~7.0-7.4% (depending on the
methodology used). We still believe this is too optimistic. Activity improved in January, but remained below pre-demonetisation levels and was not yet broad-based (see
India: Proprietary indices suggest a shallow recovery in January; rates on hold,
20 February 2017). For example, the services PMI stood at 48.7 in January, below 49.3 in Q4 2016, while the manufacturing PMI stood at 50.4 vs. 52.1. Hence, we expect the slowdown to spill over into Q1 with GDP growth slowing to 6.7% (revised up from 5.7%).
Beyond Q1, we are optimistic. Remonetisation is progressing well: currency in circulation stood at 7.2% of GDP as of 10 February, from a low of 5.9% on 6 January, and we expect a ratio of close to 9% by
the end of March. The benefits from demonetisation – lower lending rates and fiscal gains for the government – should gradually start to flow through, while pay hikes for state government employees should benefit consumption demand. The improvement in global
growth is also a tailwind. Overall, we expect growth of 6.8% y-o-y in Q2 and an average of ~7.5% in H2 2017 (see
India: Impact of demonetisation to be transitory, not long-lasting,
17 January 2017). In the light of our higher Q1 forecast, we are revising up our 2017 GDP growth forecast to 7% versus 6.9% earlier.
RBI to stay on hold
On the policy front, as remonetisation progresses, some of the disinflationary effects of demonetisation should also start to fade. We expect higher perishables price inflation, a narrowing output gap,
higher rural | 
