NEW DELHI: India’s decision to scrap some high-value notes will significantly
disrupt
economic activity, result in weaker consumption and economic growth in the immediate term but is expected to boost tax revenues and trigger faster fiscal consolidation in the long run, global ratings agency Moody’s said on Thursday.
“Corporates will see economic activity decline, with lower sales volumes and cash flows. Those directly exposed to retail sales will be most affected,” Laura Acres, a managing director in Moody’s Corporate Finance Group said in a new report on demonetisation.
In a separate analysis, the Centre for Monitoring Indian Economy (
CMIE
) estimated the
transaction cost
of demonetisation at
Rs 1.28 lakh crore
.
“All estimates are limited to the 50-day window. However, the impact of low liquidity, broken supply chains and loss of confidence in consumers is likely to impact the economy over a longer period. Therefore, the transaction cost of this exercise is more than the Rs 1.28 lakh crore estimated here, which is limited to the 50-day window till December 30,” Mahesh Vyas, managing director of CMIE, said in a report.
Moody’s said households and businesses will experience liquidity shortages as cash is taken out of the system, with a daily limit on the amount in old notes that can be exchanged into new notes. (The government stopped the exchange from Friday).
In addition, there will be a loss of wealth for individuals and corporates with unreported income, as some will choose not to deposit funds back into the formal financial system to avoid disclosing sources of these funds, the agency said.
The agency said the move would improve the overall operating environment for doing business in India — by improving the ease and speed at which payments reach manufacturers and reducing corruption — but would prolong the economic disruption. “However, greater formalization of economic and financial activity would ultimately help broaden the tax base and expand usage of the financial system, which would be credit positive,” Moody’s said.
Consumption in India is still largely cash-driven, and a move towards digital payments would require a likely gradual change in consumer habits, it added. “Banks would benefit significantly from a move towards digital payments, given their role as intermediaries for such transactions. In addition, rising bank deposits — which Moody’s expects to increase by 1-2% as a result of demonetization — could lower lending rates, a positive for banks.”
In the nearer term, however, Moody’s expects asset quality to deteriorate for banks and non-bank finance companies, as the economic disruption will significantly impact ability of borrowers to repay loans, mainly in case of loans against property, commercial vehicle and micro finance sectors.
“A prolonged disruption could also have a more significant impact on asset quality, as both corporate and small- and medium-sized enterprise customer have a limited ability to withstand a sustained period of economic weakness,” Moody’s said.