Demonetization to disrupt economic activity but in long run can boost tax revenues: Moody’s

25 Nov 2016 Evaluate

Global rating agency, Moody's Investors Service in its latest report titled 'Indian Credit -- Demonetisation Is Beneficial for Indian Government and Banks; Implementation Challenges Will Disrupt Economic Activity', has said that the demonetization will ‘significantly disrupt economic activity’ and will lead to weaker growth in near-term, though in the long run it can boost tax revenues and translate into faster fiscal consolidation. It added that government’s decision to withdraw Rs 500 and Rs 1000 old currency notes from circulation is affecting all sectors of the economy to various extent, with banks being the key beneficiaries.

Moody’s said that although the measures in the near term will pressure Gross Domestic Product (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. It said that 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 the sources of these funds. It added that 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.

Talking about the corporates, the report said that corporates will see economic activity decline, with lower sales volumes and cash flows, with those directly exposed to retail sales most affected. However, it added that 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. Though, on positive side Moody’s said that banks would benefit significantly from a move towards digital payments, given their role as intermediaries for such transactions. It expects the banks’ deposits to increase by 1-2 percent as a result of demonetization and could lower lending rates. However, in near term it expects asset quality to deteriorate for banks and non-bank finance companies, as the economic disruption will significantly impact the ability of borrowers to repay loans, in particular for the loans against property, commercial vehicles and micro finance sectors.

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Demonetization to disrupt economic activity but in long run can boost tax revenues: Moody’s

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