The National Democratic Alliance (NDA) government has long been aware that the ‘nationalism’ plank can deliver limited results and the party must explore another plank on the basis of which it can attract votes. In a bid to close this gap, the promise of ‘development’ and ‘jobs’ was the core calling card that the NDA deployed in the 2014 General Elections. Now that it is clear that progress on the job creation front has been patchy, it would appear that the government is keen to tap into another economic issue with cross-sectional, mass appeal: the black money crackdown.

Additionally, it seems like the black money crackdown is propelled by the prime minister’s desire to create a ‘new equilibrium’ for the broader economy – an equilibrium in which the routine evasion of tax, minimum wages and myriad other industrial laws is minimised. Hence, the next logical step is likely to be to launch more measures to curb the size of the black economy. These measures could potentially include bans on cash transactions exceeding a certain threshold, seizure of properties where the title cannot be verified, seizure of gold where the owner cannot show proof of purchase or inheritance, prosecution of those who have used Jan Dhan accounts to launder their wealth, punitive taxation of those who have used their bank accounts after 9 November to park black money, etc. In short, the PM, emboldened by the knowledge that his pursuit is morally appropriate, is likely to be determined to do whatever it takes to emerge triumphant in this crusade against black money.

Against this backdrop, Budget 2017 assumes tremendous importance as it will be the first major government announcement following the decision to demonetise currency that accounts for 86% of the total currency in circulation, which has created a great deal of hardships for the common man. We expect Budget 2017 to be characterised by three sets of features: (1) a significant increase in fiscal transfers for the lowest economic strata, most probably in the form of a pilot ‘universal basic income’ scheme; (2) a deviation of ~30bps from the stated fiscal deficit target of 3% of GDP in FY2017-18; and (3) improved monitoring mechanisms for property tax collection and a reduction of subsidies for the rich.

We expect GDP growth to decelerate from 6.4% in the first half of FY2016-17 (as per Ambit’s estimate) to 0.5% year-on-year in the second half of FY2016-17. Furthermore, we expect investment growth to remain weak in FY2017-18 as a shell-shocked private sector tries to absorb the ongoing battering of the black economy. To some extent, weakness in investment will be compensated by an increased growth in government expenditure and consumption. Thus, GDP growth should recover from 3.8% in FY2016-17 to between 5% and 6% in FY2017-18.

In light of the above, the first half of 2017 looks likely to bring copious amounts of bad news on corporate earnings (which have barely grown in India over the past four years). This in turn seems likely to presage a correction in the stock market as domestic investors, whose inflows have neutralised foreign investors’ outflows over the past year, finally throw in the towel. This correction in the stock market will particularly impact companies which lend money to small businesses and those that are plays on the construction cycle. However, over a 18-24 month horizon, the broader market should rally as it becomes apparent that the NDA’s attack on black money is delivering a more efficient economy with lower cost of capital, lower cost of land and real estate, less tax evasion and a smaller unorganised sector. The big winners over a 18-24 month horizon will therefore be sector-leading franchises with strong balance sheets, high quality management teams and, ideally, the ability to consolidate smaller players in their sectors and then become large-scale global exporters. We are likely to see more structural change in the Indian economy over the next two years, than we have seen in the last two decades.

The main risk to the above hypothesis is the Uttar Pradesh assembly election in the spring of 2017. UP is not only the most populous state in India, it is politically the most important state in the country with the most number of seats in the Lok Sabha. The UP elections will be an acid test of the political viability of demonetisation. In other words, does an all-out attack on black money deliver votes? A reverse in this key assembly election could lead to the above narrative coming under pressure.

Saurabh Mukherjea is the chief executive and Ritika Mankar-Mukherjee, a senior economist at Ambit Capital. The views expressed here are personal.

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