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Thanks to demonetization, India could lose growth crown

India could lose its title as the world's fastest expanding major economy when it reveals its growth figures for the October-December quarter on Tuesday.

The release follows a demonetization-led cash crunch that hit India's cash-heavy economy, but economists reckon that could be temporary.

Economists in a Reuters poll expected that India's quarterly gross domestic product (GDP) grew at 6.4 percent annually — well below the July-September quarter's 7.3 percent pace. If the forecast is realized, India will also fall behind China, which grew 6.8 percent on-year in the October-December quarter.

Sam Panthaky | AFP | Getty Images

"This data will be crucial as it captures the impact of the banknote ban introduced in early-November," according to economists at Singapore's DBS Bank. They believe the cash shortage likely disrupted logistics, production and supply of goods and services and affected sectors including automobiles, transportation, logistics, services and construction.

The fallout from demonetization, however, is ebbing as much of the currency affected by the policy appears to be back in circulation.

Reuters reported in January that the Reserve Bank of India (RBI) injected 9.2 trillion rupees ($135.21 billion) worth of new currency notes into the banking system to help replace the old notes that were banned in November.

According to Goldman Sachs, the RBI's pace of re-monetization was quicker than what the investment bank had expected — they revised their timeline for the effects of the cash crunch to ebb on the economy to mid-January, from an prior forecast of early February.

Data also appeared to support the notion that consumption has begun to normalize and that the effects of demonetization were waning, according to analysts at Morgan Stanley.

"We expect the impact on economic activity to normalize in the next one to two months," the analysts said, adding that consumption will likely resume its recovery path from the June quarter.

The Morgan Stanley analysts pointed to improved car sales in January, a key indicator for urban discretionary spending, and the narrowing pace of decline in sales of motorcycles, seen as a proxy for rural demand, as evidence of normalization in the Indian economy.

Local media reports said market leader Maruti Suzuki along with Hyundai, Tata Motors, Toyota and Nissan reported robust passenger vehicle sales growth in January. According to the Times of India, Maruti Suzuki saw its domestic sales rise 25.9 percent on-year.

More broadly, India's services PMI for January reached 48.7, which is up from a December print of 46.8. The manufacturing PMI in January was at 50.4 from 49.6 in December. PMI figures above 50 indicate an expansion in activities.

Private capital spending, however, remains a concern for India as companies and banks continue to struggle with bad debts and non-performing assets.

"Private capex (capital expenditure) will remain somewhat weak given the trailing excess capacity and balance sheet issues in (public sector) banks and industrial sector," said the Morgan Stanley analysts. They predicted private corporate capital expenditure will recover only as of 2018.

Last November, India unexpectedly announced all 500 and 1,000 rupee banknotes would be withdrawn from circulation, replaced by new 500 and 2,000 rupee denomination notes.

The move caught most people off-guard and led to a massive shortage of cash, which market commentators said would lead to significant short-term pain in cash-heavy sectors such as real estate, construction, gold, gems and jewelry.

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