DEMONETISATION IMPACT ON INVESTMENT: Investors reluctant to borrow, banks reluctant to lend, preferring instead to park surplus liquidity in government bonds
Impact on Investment
Entrepreneurs and business people make the decision to invest in new projects or to expand capacity based on their projections of future demand. If they are optimistic about selling more, and if their existing capacity is insufficient, they will go ahead and invest, thus adding to capital formation, the creation of new jobs, and, through this process, contribute to enhancing economic growth for the economy as a whole.
It’s important to note that finance – both its availability and its cost of funds – is a necessary but not a sufficient condition, to enhance investment levels. Even if plentiful finance is available at a very low cost, investments will not take place unless the business person believes that demand in the future will rise.
The confidence and optimism of business people and entrepreneurs is thus the critical element that drives investment and growth, and these are the fabled ‘animal spirits’ that growth-oriented governments strive to keep enthused!
The data on Projects and New Investments shows that Demonetization had a significant negative impact on both business confidence and Investments. This data collated by CMIE covers the entire spectrum of listed and unlisted companies, and is based on their disclosures to stock exchanges, government bodies, and other public information. It is, therefore, factual and not anecdotal evidence.
According to CMIE, new investment proposals by India Inc. fell to low of ₹1,25,000 crore in the December 2016 quarter, compared to the average ₹2,36,000 crore worth of new investments seen per quarter in the preceding nine quarters of the NDA government.
The impact of Demonetization was immediate and very negative as summarized in the table below:
Table 7: Impact of Demonetization on New Projects/ Investments
| Projects/Investments | Oct 1–Nov 8 2016 | Nov 9–Dec 31 2016 | Decline per cent |
| New Inv. Proposals | 227 proposals:
₹81,800 crore |
177 proposals:
₹43,700 crore |
46 per cent |
| Avg. New Projects announced | 6 | 3 | 50 per cent |
| Avg. daily value New Investments | ₹2097 crore | ₹824 crore | 60 per cent |
Source: The CMIE database on investments extends to over two decades. According to this data, the March 2009 quarter saw the highest value of investment proposals, at ₹8,21,564 crore; while the greatest number of projects were announced in the March 2011 quarter, a total of 1,676.
Unfortunately, the precipitous decline in investor confidence continued well after Demonetization. CMIE reported that new investment projects announced during the quarter Oct-Dec 2017 were the lowest for any quarter since June 2004.
Interestingly, though banks were flush with funds, credit offtake remained lukewarm. While bank deposits skyrocketed by ₹6720 billion (₹6,72,000 crore) as a result of the Demonetization bonanza, loans and advances by banks increased by only ₹1008 billion (₹1,00,800 crore) during 28 October 2016–17 February 2017 period.
This was notwithstanding the fact that banks, across the board, had reduced lending rates. The weighted average lending rate (WALR) of banks in respect of fresh rupee loans declined by 56 bps (0.56 per cent) during the period November 2016–January 2017. Similarly, the one-year median Marginal Cost of Funds Lending Rate (MCLR) declined on average by a cumulative 70 bps (0.7 per cent) during November 2016–March 2017.
What this shows is that business people were unwilling or unable invest, despite the fact interest rates had fallen. The decline in the Gross Fixed Capital Formation ratio from 28 per cent in September 2016, to 27 per cent in December 2016 and further to 25 per cent in March 2017, is a clear reflection of this fact.
Equally important, banks were also going slow on lending post Demonetization. Lending is predicated only partly on how much cash banks have; bankers lend basis their perception of the risk profile of the potential borrower. In a situation of mounting NPAs and frauds and with a major disruption in economic activities as a result of Demonetization, the risk of lending in 2017 in India was extremely high. Thus, even as investors were reluctant to borrow, banks were reluctant to lend, preferring instead to park surplus liquidity in government bonds.
Commenting on the declining investment ratio, the Economic Survey 2017-18 made some important observations:
- A one percentage point fall in investment rate is expected to dent growth by 0.4-0.7 percentage points.
- The fall in investments is mainly due to the decline in private investment. “Based on the break-up of investment and saving that is available up to 2015-16, private investment accounts for five percentage points out of the 6.3 percentage point overall investment decline over 2007-08 and 2015-16.”
- Investment slowdowns are more detrimental to growth than saving slowdowns. Over the short-run, the government’s policy priorities must focus on reviving investment.
And, in a not-so-subtle criticism of Demonetization, the Economic Survey bluntly stated: “Mobilizing saving, for example, via attempts to unearth black money and encouraging the conversion of gold into financial saving or even courting foreign saving are, to paraphrase John Maynard Keynes, important, but perhaps not as urgent as reviving investment.”
Cautioning policy makers on the perils of measures that led to declining investments, the Survey went on to warn: “Cross-country evidence indicates a notable absence of automatic bounce-backs from investment slowdowns. The deeper the slowdown, the slower and shallower the recovery… Evidence from other countries, which have gone through a similar investment slowdown, seem to suggest that a full recovery rarely happens.”
Excerpted with permission from The Big Reverse: How Demonetization Knocked India Out, by Meera H. Sanyal, HarperCollins India
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