The view that growth will only suffer a temporary blip this year because of demonetisation can be questioned. Demonetisation advocates assume that once the cash shortage is sorted out, investment and consumption will be up and running. This amounts to taking a static view of the economy.

The withdrawal of currency, with cashless transactions not in a position to fill the gap, reduces employment, and hence investment and consumption in the future. But when the currency is eventually restored, the process may not work in reverse because the ability or inclination to invest or consume may have changed over time. So, when the finance minister says that banks, flush with funds, will be able to reduce lending rates, he forgets that today's borrowers may disappear a few months later.

A downward spiral of consumption and investment dragging each down in an amplified sequence — in economic jargon, the multiplier and accelerator acting in reverse — can set in. Units would have shut down, workers would have dispersed, assets would have been sold off and the interest to start all over again would have dissipated. Informal credit may have provided a lifeline to many, but given the high rates of interest, that could turn out to be a liability. There is no question of banks lending more, even if the lending rates drop — besides their NPA phobia, their staff doesn’t have the time these days to process loans.

On the credit demand side, investment has been anaemic, despite the drop in rates since January 2015. It can hardly be expected to pick up in times of income and wealth compression. Political and policy uncertainty — add to this, rising commodity prices and the Trump factor — can impact investment.

A fall in the demand and supply of credit is a key feature of recessions. Fiscal stimulus is the only way out — the threats to jobs and growth are no less than in 2008, or 1928!

Senior Deputy Editor

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