Hit hard by demonetisation, the services sector slipped into contraction in November — the worst slump in nearly three years — as new orders dried up and customers cut spending due to cash shortages, putting pressure on the Reserve Bank of India to keep rates low, a monthly survey showed on Monday.
The Nikkei/Markit Services Purchasing Managers’ Index sank to 46.7 in November from October’s 54.5, the first time since June 2015 that the index has gone below the 50-mark that separates growth from contraction.
It was also the biggest one-month drop since November 2008, just after the collapse of Lehman Brothers triggered the global financial crisis.
Due to cash crunch in the economy post demonetisation, businesses declined in financial intermediation, hotels and restaurants, and renting activities.
“The latest set of gloomy PMI figures for the Indian services sector shows that companies were heavily impacted by the ban on R500 and R1,000 notes. The cash shortage resulted in fewer new business intakes, which in turn, caused a fall in activity and ended a 16-month sequence of expansion,” said Pollyanna De Lima, IHS Markit economist and author of the report.
The Nikkei India Composite PMI Output Index also dropped to 49.1 in November from October’s 45-month high of 55.4, pointing to a contraction in the entire private sector activity, including the manufacturing sector.
“The drop in services activity is not surprising since the share of the unorganised sector in services (around 45% of the total, as per 2004-05 data) is much higher than in manufacturing (around 23%), suggesting larger dependence on cash transactions,” Japanese financial services major Nomura said in a research note.
De Lima added that the disruption in business activity is expected to be “short-lived”, with many panellists anticipating a pick-up in activity as these high-value banknotes are replaced and black-market firms end their operations.
“In fact, business confidence improved to a three-month high,” De Lima said.
India’s services sector makes up over 60% of gross domestic product, so a contraction there is likely to drastically weaken the growth outlook.
A slowdown could rob India of its fastest growing major economy tag. Some of the more pessimistic views are that growth will halve from the annual 7.3% clocked in July-September.
Firms also discounted prices at a steeper rate than in October, the survey showed, to try and convince buyers to part with the limited available cash.
“The reduction in money supply curbed inflation in November. In light of these numbers, further cuts to the benchmark rate are expected,” De Lima said.
Expectations of replacement of high-value notes, improved advertising campaigns, favourable government policies and the withdrawal of unregulated companies from the market have boosted sentiment for the coming 12 months, the survey noted.
On the prices front, the reduction in money supply kept inflation in check in November. Input costs facing service providers were broadly unchanged, which in turn encouraged firms to lower their selling prices.
“In light of these numbers, further cuts to the benchmark rate are expected,” De Lima said.
The Monetary Policy Committee, headed by RBI governor Urjit Patel, in October cut benchmark interest rates by 25 basis points to 6.25%. The next RBI policy review is on December 7.
