India shrugs off demonetisation concerns with GDP surprise

Indian GDP surprised to the upside for the final quarter of 2016, growing 7% year-on-year, slower than 7.4% in the previous quarter but better than a market consensus of 6.1%, and our own expectation for 6.5% growth. We had warned that consensus was likely overestimating the impact of demonetisation on the economy, but it would appear even then we were still too negative.

A breakdown of the expenditure data shows private consumption accelerating despite the withdrawal of over 85% of notes from circulation. In fact, the only negative impacts came from net trade, with imports climbing more than exports, and valuables. Investment, consumption and government spending all rose.

In one sense, this is good news for the Indian economy. Extremely negative expectations have been confounded and growth has faced only the mildest of interruptions. However, it does imply that the demonetisation policy likely failed in its aim to tackle black money. For consumption to soldier on unaffected suggests that there has been little wealth shock, and indeed central bank data shows that 97% or more of the old notes were returned.

This also suggests the central bank was right to end its easing cycle: activity needs less of a prop than had been imagined by the market, and inflation could prove more robust as a result. With elections ahead, this is also a boost for Prime Minister Modi’s government, and to us would seem to raise the odds of successful passage of the Goods and Services Tax this year.