Indian GDP Growth Hurt by New Delhi’s Cash Crackdown

NEW DELHI—Growth in India’s gross domestic product slowed to a two-year low late last year as Prime Minister Narendra Modi’s sudden crackdown on the use of cash, a move intended to fight crime, hindered consumer and corporate demand.

Asia’s third-largest economy grew a greater-than-expected 7% from a year ago in the three months through December, according to government data released Tuesday. That is down from 7.4% in the preceding quarter and the slowest growth the South Asian nation has recorded since the end of 2014.

Economists surveyed by The Wall Street Journal had expected quarterly growth to be less than 6.5%, after Mr. Modi’s overnight move in November to nullify 86% of the rupees in circulation crimped the consumption of everything from carrots to cars.

“The message is that demonetization did have an impact, but it did not lead to a collapse in the economy as some were fearing,” said Abheek Barua, chief economist at HDFC Bank. “Getting away with such a (strong GDP) number when there was such a shock in the economy is relatively remarkable.”

Despite losing momentum, India maintained its top spot as the world’s fastest-growing large economy, a title it has held for close to two years. China’s economy expanded 6.8% during the quarter.

On Nov. 8, New Delhi announced that billions of 500- and 1,000-rupee notes ($7.50 and $15) in circulation were no longer legal currency—the largest denomination notes in the largely cash-powered economy.

The move was aimed at curbing corruption, thwarting counterfeiters and dredging up billions stashed in the underground economy. But there were other ripple effects.

Hundreds of millions of people had to put off purchases and stand in line at banks to exchange or deposit their existing bills.

Evidence of disruption was seen in construction activity as well as some services. Growth in construction slid to 2.7% from 3.4% in the preceding three months, while the output of real-estate and professional-service providers grew 3.1%, compared with a 7.6% increase in the prior three months.

Other sectors performed better despite complaints from many companies that they had experienced a sharp decline in demand.

Farm production accelerated to 6% from 3.8%, mining expanded 7.5% after shrinking 1.3% three months before.

Manufacturing growth strengthened to 8.3% from 6.9% while services grew 7.2% in the three months through December, improving from a 6.9% expansion.

While India has been minting new bills at a record rate, the lingering scarcity of cash could hurt demand for months to come as consumers wait for more new bills and slowly switch to cashless transactions, including cellphone apps and credit cards.

The government predicted growth would slide to 7.1% in the full fiscal year ending March 31, from 7.9% last year. That would be India’s lowest growth rate in three years.

New Delhi is optimistic the move on cash will eventually help bring more people into the banking system and onto the tax rolls, giving banks more money to lend to companies and the government more money to spend on infrastructure.

“The post-demonetization regime is actually going to generate a far bigger GDP in the long run,” Finance Minister Arun Jaitley said Monday at an event in London.

Economists aren’t so sure. There was already too much slack in the Indian economy, they say, so there are not enough productive outlets for all the new rupees that have poured into the banking system.

According to the most recent Indian central bank estimates, Indian manufacturing facilities are operating at about 72% of capacity, reflecting significant spare capacity. Until that figure rises to about 80%, businesses won’t be inclined to spend on expansion plans in anticipation of a rise in demand, said Madan Sabnavis, chief economist at Care Ratings.

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