Nearly three months after the demonetisation measure was taken, its negative impact continues to be felt on the Indian economic activity. Weakened industrial production and delayed consumer demand are the most significant consequences. According to recent IMF estimates, GDP growth is expected to fall from 7.6% to 6.6% in the 2016/17 fiscal year (ending in March 2017). Then, as the cash shortage fades, a rebound in total economic activity is forecast at +7.2% in the 2017/18 fiscal year. On the budget side, the central government is still likely to slightly reduce its deficit towards 3.8% of GDP. Its commitment to fiscal consolidation is unchanged with a view to reversing the evolution of a heavy public debt close to 70% of GDP. New Delhi hopes that a structural fiscal boost will come from the National Goods and Services Tax (GST) which is nevertheless not expected to be implemented before the third quarter of 2017 at the earliest.

Impact on country risk

Since demonetisation has hit the rural poor the most, upcoming key state elections are uncertain to benefit Mr Modi’s BJP party. They will tell whether Modi’s gamble on launching a badly prepared policy mostly motivated by anti-corruption and tax evasion grounds, delivers the desired political outcomes. Elections in Uttar Pradesh (to be held from mid-February), a rural poor and the country’s most populous state, will be a crucial test for PM Modi not only to assess his government room for manoeuvre for moving forward reforms but also to assess his popularity. His centralised style of governance is indeed becoming more controversial for India’s institutional balance and within his party. Failure to achieve the necessary electoral gains, a possibility after the defeat at Bihar elections in 2016 and given the demonetisation context, might weaken his intra-party position. On the other hand, a victory for a PM seen as a charismatic man of action will greatly strengthen his personalised rule and chances of a second PM mandate.

Analyst: Raphaël Cecchi, r.cecchi@credendo.com