MUMBAI (BLOOMBERG) - Indian Prime Minister Narendra Modi needs a new narrative for his banknote ban.
He had touted the surprise move to scrap high-value bills as India's biggest step against unaccounted cash, which the government estimated at 5 trillion rupees (S$106.48 billion). The bulk of this money has already been deposited with two more weeks to go before the deadline lapses, meaning the shock to the system may have been in vain.
The decision sucked out 86 per cent of currency in circulation, akin to withdrawing all US dollar bills except for about half of the US$1 notes. Only 50 per cent of this is projected to be replaced by the year-end, leaving the authorities scrambling to push digital payments as public anger rises.
"India's 'own goal' currency swap initiative has put a crimp on the cash-dependent economy," said Singapore-based Paul Gruenwald, chief economist for Asia-Pacific at S&P Global. The government's "well-intentioned but poorly thought through demonetisation programme" is driving down the pace of economic activity, he said.
As investors try to assess the impact of Mr Modi's move, all eyes will be on the government's forecast for the year through March - due on Jan 7. The central bank and private economists have lowered their projections for the economy where 98 per cent of consumer payments are made in cash.
The Nikkei purchasing managers' index signals a contraction in the key services sector, which accounts for about 60 per cent of gross domestic product. Car purchases, a main indicator of manufacturing demand, grew at the slowest pace in nine months in November while sales of motorcycles and scooters - where about 65 per cent of payments are in cash - fell for the first time in almost a year.
Commercial credit sank to a 19-year low as backlogs piled up at factories and banks stayed busy with the task of exchanging currency notes. Meanwhile deposits surged, pushing the credit-deposit ratio to a six-year low.
"For a cash dependent economy, a cash crunch is not good," said Ms Madhavi Arora, Mumbai-based economist at Kotak Mahindra Bank.
The trade deficit widened to a 16-month high as export growth slowed in November and imports surged. Most worryingly, gold shipments jumped 26 per cent in November, triggering speculation that consumers were converting their cash into non-productive holdings of the precious metal.
Export numbers also hinted at the employment outlook. A decline in gems and jewellery, a sector that depends on unorganised manual labour, suggested the cash crunch was affecting employment, said Mr Kapil Gupta, an analyst at Edelweiss Securities. Mr Rafeeque Ahmed, chairman of the council for leather exports, said Mr Modi's move has slashed about 75,000-100,000 jobs from his industry.
As demand dips for goods, price pressures are easing. The benchmark consumer inflation gauge plunged more than estimated to below the mid-point of the central bank's target. However, this would not be the first time that economists have been surprised and it may not open much room to ease policy. So-called core inflation - excluding food and fuel - is sticky, the central bank said this month.
India's currency clampdown will not have an effect on the nation's credit ratings, according to S&P Global Ratings. But the company said Indian corporates and banks will face short-term "execution and adjustment risks".
Fitch Ratings called the demonetisation a "one-off event" and said that while the short term hit will be significant, people will find "inventive ways" around the cash crunch. Moody's Investors Service placed on negative watch three micro-finance lenders, indicating that their ratings may be downgraded.
Data on card transactions indicate plastic is taking the place of currency usage at a faster pace. With the data incomplete, conclusions are tentative, but the analysis strengthens Bloomberg Intelligence Economics' view that demonetisation will not deal a major blow to growth.
A central bank survey of 4,686 respondents also pointed to robust consumer sentiment despite the cash ban. Perceptions of general economic conditions and financial situations have improved, the central bank said on Dec 7, adding that the surveys were conducted between Oct 27 and Nov 13 and more data must be analysed to draw conclusions.
"A puzzle has arisen of late - why are some activity indicators still in the positive range, albeit slowing, when cash has contracted so sharply?" said Ms Pranjul Bhandari, chief India economist at HSBC Holdings. "One answer might be that growth will be affected with only a lag. Another is that informal arrangements, like vendor credit, have helped to fill the void."