Demonetisation impacted 'material spending' and slowed GDP: Fitch

New Delhi: Demonetisation of old Rs 500 and 1,000 notes had a "material impact on spending" as reflected in significant slowing of GDP growth in January-March, Fitch Ratings said today, warning that the ongoing steep decline in investment could spell risks to growth potential.

In its latest Global Economic Outlook (GEO), Fitch said Indian GDP growth slowed "significantly" to 6.1 per cent in first quarter of 2017 from 7 per cent in October-December. This was the slowest pace since fourth quarter of 2013-14. "Domestic demand accounted for the bulk of the slowdown. It appears that the cash squeeze of November 2016 – whereby the government pulled 86 per cent of cash in circulation out of the economy virtually overnight – finally did have a material impact on spending," it said.

Stating that the lagged effect of demonetisation on the economy is "quite puzzling", Fitch said this partly reflects the challenges of measuring spending in an economy with a large informal sector. Consumption growth fell substantially to 7.3 per cent, from 11.3 per cent in the fourth quarter of 2015-16. "More worryingly, investment dipped into negative territory (-2.1 per cent). This partly reflected poor construction activity, which fell by 3.7 per cent, an unprecedented low level in recent years," it said, adding that this may have been affected by the demonetisation shock.

Stating that investment has been persistently weak in recent years, Fitch said investment as a share of GDP has been trending down for several years and "ongoing steep declines could spell risks for medium-to-long term growth potential. We do, however, expect investment to gradually pick up from current lows on the back of the transmission of supportive monetary policy of the past two years and stepped-up structural reforms," the rating agency said.

Fitch expected that the goods and services tax (GST), which is to kick in from July, will facilitate trade within India and reduce transaction costs. Also, public spending on infrastructure is set to rise, boosting investment. "This should help drive a pick-up in GDP growth, which we forecast at 7.4-7.6 per cent in the next two fiscal years," it said.

CPI inflation, it felt, should also tick up as the current low food price effect will fade, but would remain firmly within the central bank's target range.

Fitch said the recovery in global growth is strengthening and is expected to pick up to 2.9 per cent this year and peak to 3.1 per cent in 2018, the highest such rate since 2010. "Faster growth this year reflects a synchronised improvement across both advanced and emerging market economies. Macro policies and tightening labour markets are supporting demand growth in advanced countries, while the turnaround in China's housing market since 2015 and the recovery in commodity prices from early 2016 have fuelled a rebound in emerging market demand," said Brian Coulton, Fitch's Chief Economist.