Demonetizations to raise government revenue but unlikely to support credit profiles: Fitch

23 Nov 2016 Evaluate

Global ratings agency, Fitch Ratings in its latest report has said that the surprise move of demonetizations of old Rs. 500, 1,000 has the potential to raise government revenue and encourage bank lending, but at the same time the positive effects are unlikely to be strong and sufficiently enduring to support credit profiles. The rating agency said that the impact on GDP growth will increase, the longer the disruption continues, but we will already need to revise down our forecasts to reflect what will almost certainly be a weak 4Q16.

The report further said that the discontinuation of the large denomination notes has led to a short-term disruption in India’s economy. The withdrawal of bank notes has created a cash crunch, with the time spent queuing up outside banks affecting general productivity. Following the announcement, the consumers have not had the cash to complete purchases, and there have been reports of supply chains being disrupted. Also, farmers incapable to buy seeds and fertiliser for the sowing season.

As per the report, the move by the government could also affect sectors that rely on cash transactions and have a negative impact on bank asset quality. Most importantly, demonetizations 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.

However, Fitch pointed that the move could boost government revenue to the extent that demonetizations helps to move economic activity from the informal to the formal sector, as more earnings would be declared. It is possible that this positive effect would soon outweigh the drag on revenue collection from lower short-term GDP growth. Government finances may also benefit from a proportion of high-denomination notes not being traded. On November 8, 2016, the government had declared demonetisation of Rs 500 and Rs 1,000 note replacing them with new Rs 500 and Rs 2,000 notes to curb corruption and make efforts to recover ‘black’ or unaccounted money.

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