Demonetisation beneficial, but implementation may slow down GDP growth: Moody's

The Dollar Business Bureau

Credit ratings agency Moody's said the recent decision of demonetisation is beneficial for both the Indian government and banks, but execution challenges of this "unprecedented move" will disrupt the country’s economic activity, resulting in a slow GDP growth for a few quarters.

The new development will have credit implications for almost every sector, since the decline in economic activity will contract corporate sales cash flows. 

"Although the measures in the near term will pressure GDP growth and thereby government revenues, in the longer term they should boost tax revenues and translate into higher government capital expenditure and/or faster fiscal consolidation," Marie Diron, associate managing director in Moody's Sovereign Group said in a statement.

Highlighting some of the sectors with significant economic impacts, Moody’s said the sectors having a more direct exposure to retail sales such as telecom and auto, or with the maximum exposure to sales in rural areas like farm equipment manufacturers will be impacted the most.

In addition, households and businesses will witness liquidity shortages, leading to a loss of wealth for individuals and companies with unreported income, since many people will be reluctant to deposit their funds in the formal financial system. Meanwhile, the demand for traditional stores of value of unreported income, including real estate, gold and jewellery will also come down considerably.

"The quantitative economic effect of an unprecedented measure with untested responses by households, corporates and banks is highly uncertain," Moody’s said.

Referring to the impacts of demonetisation on the country’s GDP growth rate, the agency said there will of course be a weaker GDP growth rate temporarily, but a prolonged disruption would dampen GDP growth for even a much longer period.

However, “demonetisation demonstrates the Indian government's commitment to addressing tax avoidance and corruption, which, if effective, will lift tax revenue collection,” it said.

"Demonetisation, together with other revenue-enhancing policy measures, such as the implementation of the Goods and Services Tax (GST), will ultimately contribute to raising the revenue intensity of economic activity," it said. 

Moody's said the demonetisation would benefit the banks the most, as a successful implementation would translate into a greater use of the formal financial system, particularly in retail segment. Demonetisation will also stimulate the development of electronic retail payment system. Bank deposits could rise 1-2%, benefiting from a strong impetus to use the formal financial system for the intermediation of commercial transactions, especially in the retail segment, it noted.