Positive effects of demonetisation unlikely to be strong or long lasting: Fitch

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MUMBAI: The positive effects of demonetisation is unlikely to be strong or long lasting to make a significant difference to government finances or medium term growth prospects, global credit rating agency Fitch said in its bi-monthly newsletter released on Tuesday.

“The intentions behind demonetisation were positive and in keeping with broader reform efforts, but the short-term pain might outweigh the uncertain long-term gains,” Dan Martin, senior analyst at Fitch said in the newsletter.

Fitch has already downgraded India’s economic growth forecast for the current fiscal year ending March to 6.9% from 7.4% citing the disruption caused due to the withdrawal of high denominated currency. “The withdrawal of bank notes has left consumers without the cash needed to complete purchases and farmers without the funds to buy seeds and fertiliser for the sowing season. Supply chains have been disrupted and time spent queueing in banks has meant lost hours of productive work. The impact on the economy will increase the longer the disruption continues,” Martin said.

The rating agency acknowledged that demonetisation could boost government revenue as economic activity moves from informal to formal sector, and more earnings are declared. “It is possible that this positive effect would soon outweigh the drag on revenue collection from lower short-term economic activity. Government finances may also benefit from a proportion of high-denomination notes not being traded,” Martin said.

However, there are considerable uncertainties over the potential positive effects mainly because demonetisation is a one-off event. “People that operate in the informal sector will still be able to use the new high denomination bills and other options (like gold) to store their wealth,” Martin said. The informal sector could soon go back to business as usual in the absence of new incentives to avoid cash transactions, he said.

“There are similar uncertainties over the impact on the banking sector. Some banks have already reported large increases in deposits since demonetisation began. A surge in low-cost funding might encourage credit growth and support the economy. However, demonetisation could also affect the ability of some borrowers, especially SMEs, to service their loans, with negative effects on bank asset quality. Moreover, the positive impact on funding conditions will depend on deposits remaining in banks beyond the next few months. There is nothing to prevent them being withdrawn again,