In Five Charts, RBI’s Assessment of Demonetisation

The loop on the demonetisation process closed this week, with all restrictions on the withdrawal of cash being lifted starting Monday. The decision to withdraw 86 percent of the country’s currency, announced on 8 November, had led to considerable uncertainty about the likely impact on the economy and the banking sector.

As the process draws to a close, the Reserve Bank of India (RBI), on Saturday, issued its assessment of the first round impact of the currency replacement exercise.

Don’t Blame The Entire Slowdown On Demonetisation

Official growth estimates suggest that gross value added (GVA) growth slowed only marginally in the third quarter to 6.6 percent compared to 6.7 percent in the previous quarter. For the full year, the RBI estimates GVA growth of 6.9 percent, compared to its initial estimate of 7.6 percent.

This, however, cannot be entirely blamed on demonetisation, said the central bank in the paper released on Friday.

Reserve Bank of India  Of the 70 basis points (bps) downward revision in overall GVA growth in 2016 – 17, 33 basis points (bps) was estimated on account of demonetisation, and the remaining 37 bps due to the loss of momentum in Q2 (as per quarterly data released by the CSO in November 2016), which was assumed to have persisted through H2.  

The central bank expects any lingering growth impact of demonetisation to dissipate by next fiscal. With rapid remonetisation, pent up demand was likely to boost consumption demand, said the RBI. It added that investment demand may also get a boost due to lower interest rates.

Inflation Impact Restricted To Food

The impact of demonetisation on inflation was restricted to the fall in food prices, said the RBI, while adding that there were other reasons for the drop in food prices.

Reserve Bank of India The sharp decline of about 240 bps in food inflation between October 2016 and January 2017 reflected the combined impact of record pulses production, large winter arrivals of vegetables and compression in demand due to demonetisation.  

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In the RBI’s analysis, the downward pressure on prices of perishables, more than made up for any upward pressure that may have resulted from a disruption in supply chains. The central bank is also of the view that apart from food prices, demonetisation had little impact on the inflation trajectory.

Core inflation, which has been sticky, has in fact risen marginally after demonetisation. If vegetable prices also start to rise as the process of remonetisation is completed, headline retail inflation could start to move up, cautioned the central bank. In February, wholesale inflation jumped sharply to 6.55 percent while retail inflation rose marginally to 3.65 percent.

Deposits Surge, Costs Fall For Banks

Banks have been big beneficiaries of demonetisation, although they also bore the brunt of the logistical challenge faced during the currency swap exercise.

Aggregate deposits in the banking system saw a sharp increase of about Rs 6.7 lakh crore, even after accounting for outflows in non-resident deposits during the period, said the RBI. Deposits in no-frill Jan Dhan accounts also surged, suggesting that a greater proportion of the currency in circulation could not flow through the banking sector.

Jan Dhan accounts contributed 4.6 percent in total accretion of aggregate deposits of scheduled commercial banks in the post-demonetisation period, according to the RBI’s data.

In the absence of demand for credit, a bulk of fresh deposits were either parked with the central bank or invested in the bond markets. Analysing the costs and benefits for banks, the RBI noted that since most of the funds came in the form of low-cost current account saving account (CASA) deposits, the cost of aggregate deposits came down.

The cost of CASA deposits at 3.2 percent is significantly lower than the weighted average term deposit rate at 7.1 percent, noted the central bank.

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Reserve Bank of India Banks earned return of around 6.23-6.33 percent under reverse repos and market stabilisation scheme (MSS), as against the cost of CASA deposits of around 3.2 percent. Accordingly, for an average deployment of about Rs 6 lakh crore in a quarter under reverse repos and MSS securities, banks’ net interest income from increased deposits is estimated at about Rs 45,000 crore in a quarter after demonetisation. Banks continue to enjoy the increased share of low cost CASA deposits, although it is gradually declining with the increase in currency in circulation.  

To be sure, banks incurred costs during the demonetisation phase as well. These costs ranged from cost of managing the currency exchange operations, recalibration of ATMs and lower fee on digital payments. The exact details of these costs, however, are not known, said the RBI.

Digital Payments Gain

With cash in short supply, citizens took to digital payments. Representative data by the central bank shows that the volume and value of transactions has risen significantly between November 2016 and February 2017, although it had moderated from the peak hit in December.

Channels such as the Unified Payment Interface (UPI), prepaid instruments like mobile wallets and debit and credit cards, saw increased usage due to the low availability of cash. The RBI, however, acknowledged that ensuring the surge in digital payment sticks may not be easy.

Reserve Bank of India The catalytic push from demonetisation hastened migration towards digital payments in November and December 2016. However, ease in availability of cash by progressive remonetisation impacted the pace of growth of digitalisation in February 2017. Further efforts are essential to enhance the use of digital payment going forward.

Volatility In Gold Imports

The decision to demonetise had led to chatter on the likely impact on gold. On the one hand, people could have rushed to exchange old currency notes for gold, thereby increasing demand. On the other hand, cash purchases of gold could have been hit due to the lack of currency.

Data on gold imports shows conflicting trends. While imports surged in November, they fell sharply in subsequent months. According to the RBI’s analysis, this suggests that while some panic buying took place in November, it subsided quickly.

Reserve Bank of India  After demonetisation, domestic demand for gold (or gold items) spiked suddenly, with buyers reportedly willing to pay huge premiums to dispose of old currency notes with jewellers. Reflecting this development, as well as the seasonal jump, the volume of gold imports surged in November, even above the elevated October level.  Reserve Bank of India  Gold imports, however, declined sharply in December 2016 and January 2017. As around 80 percent of the gems and jewellery purchases in India are made in cash, consumer demand was reported to have been impacted due to the cash shortage.  

(The article was originally published on BloombergQuint.)