Rating agencies see long-term gains from demonetisation

26 Nov 2016


International rating agencies, Moody's Investor Service and Standard and Poor's, have given the thumbs-up to the government's decision to demonetise high-value currency notes saying it is worth the short-term pain.

Moody's Investor Service on Thursday said while demonetisation will ''disrupt economic activity'' and dampen economic growth in the short term, it would boost tax revenue and hasten fiscal consolidation in the longer term.

''The move will weigh on GDP growth for a few quarters, dampening government revenues,'' it said, adding that in the medium term, higher income declarations will boost tax revenues, and the government could receive a one-off transfer of the central bank's gain.

This, in turn, would enable higher capital expenditure by the government and fiscal consolidation, which would be credit-positive for the sovereign, it said in a report.

The 8 November announcement by Prime Minister Narendra Modi on the withdrawal of all Rs500 and Rs1,000 notes from circulation, left the financial sector with an 86-per cent fall in the currency in circulation.

While his was a measure to combat black money and counterfeiters, the move brought about liquidity shortages all around, handicapping wage earners and small traders more.

''Households and businesses will experience liquidity shortages, at least for a few months,'' said the report, adding that businesses with direct exposure to retail sales and rural areas, such as in the telecom and auto sectors and farm equipment manufacturers, will see sales volumes and cash flows taking a hit.

However, Moody's said that while bank deposits may increase by 1-2 per cent, asset quality in loans against property and commercial vehicle segment may deteriorate.

''Cash collection in the micro-finance segment could also initially receive a hit. But central bank measures will limit short-term asset quality pressures,'' it further warned said.

S&P further said that though India's low-income economy constrains its economic resilience, improvements in policy-making continue to boost the medium-term prospects for India's economic and fiscal performance.

Moody's, however, said in the medium to longer term, it would be more beneficial. ''Greater formalisation of economic and financial activity would ultimately help broaden the tax base and expand usage of the financial system, which would be credit-positive,'' it said.

It also noted that the move towards non-cash transactions and digital payments would enhance the ease of doing business.

Similarly, S&P said that while demonetisation is ''a long-term positive'', it will have a transitory impact on growth in the short term and could hurt asset quality. ''Bank deposits would benefit due to demonetisation, though not all inflows will remain in the banking system on a permanent basis,'' it said in a report.

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