Use cash gains from demonetisation to fund state banks: IMF

Demonetisation will give the economy gains in the medium to long term, the International Monetary Fund (IMF) said.
 
There might be temporary disruptions, which could be underestimated by the statistics office in its provisional estimates. The benefits would come from widening of tax base, enhanced liquidity in banks and greater digitisation, the IMF said in its latest report.
 
The key factor behind the short-term economic disruptions was the primarily cash-based nature of the Indian economy and its limited electronic payments infrastructure, said IMF. It, however, flagged increasing non-performing assets of banks and corporate debt. The government should use any higher dividend from the Reserve Bank of India due to demonetisation to recapitalise public sector banks, it said.
 
The Fund had pegged India's growth projections at 6.8 per cent for 2016-17 against the official advance estimates of 7.1 per cent. "It is likely, however, that national accounts statistics, at least in the near term, may understate the economic impact of the cash crunch," the IMF said in its regional economic outlook (Asia and Pacific). The impact on the informal economy and cash-based sectors, which are relatively large and have been affected the most by the cash crunch, is likely to be understated because these sectors are either not covered in the official statistics. Nonetheless, the economic repercussions from the currency withdrawal remain a key domestic risk in India, in part as the near-term adverse economic impact of accompanying cash shortages remains difficult to gauge, it said. The IMF’s comments came in the wake of the Central Statistics Office projecting the economy to grow 7.1 per cent in 2016-17 in its two advance estimates. The provisional estimates for GDP for 2016-17 will come by this month end. The IMF had in April predicted the economy would grow 6.8 per cent in FY'17, against its earlier estimate of 6.6 per cent. IMF had projected the economy to grow by 7.2 per cent in 2017-18.
 
IMF said demonetisation would help secure some long-term gains, particularly if complemented by reforms to strengthen the formal economy and the financial system. It said the economy will benefit from fiscal gains, liquidity in banks and digitisation in the wake of demonetisation. "Bank deposits of large amounts (above $4,000) were expected to attract high scrutiny from the Indian tax authorities and the information obtained as a result of income verification could lead to a durable impact on the tax revenue base," it said.
 
With only about 1 per cent of the Indian population paying personal income taxes, the scope for broadening the tax base is clearly large.
 
In principle, unreturned cash could also produce a one off-revenue gain for the Reserve Bank of India that can enable an increased dividend transfer to the government. Any such windfall revenue would need to be clearly established, should be only realised once, and should be absorbed prudently and preferably in a non-recurring manner, for example through greater capital injections to public sector banks.
 

An increase in banking system liquidity due to demonetisation has been massive, and it can reduce banks’ funding costs and lead to a decline in bank lending rates. With a surge in bank deposits and waning demand for credit, the weighted average lending rate of banks on new loans declined by 56 basis points during November 2016 to January 2017, it said.
 
The authorities should remain vigilant to risks in view of potential building up of non-performing loans, including among private banks, and elevated corporate sector vulnerabilities, it warned.
 
The demonetisation initiative can be seen as a follow-up to authorities’ strong policy push toward greater financial inclusion.
 
Over the past few years, 250 million previously unbanked Indians have been provided with bank accounts. More efficient customer identification is now in place, including with Aadhaar and adoption of know-your-customer technologies.
 
More recently, an important technological milestone was the roll-out of the Unified Payment Interface, which is an instant virtual fund transfer service between two bank accounts using a mobile platform, it added.