Demonetisation a short term pain for long term gain: Moody's

The demonetisation of old 500 and 1,000 rupee notes by the government will result in increasing tax revenue, higher government capital expenditure and faster fiscal consolidation, said Moody's Investors Service.

In report released on Thursday, Moody's said the demonetisation is affecting all sectors of the economy to various extents, with banks being the key beneficiary.

"Although the measures in the near term will pressure GDP (gross domestic product) 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," said Marie Diron, an Associate Managing Director in Moody's Sovereign Group.

"Corporates will see economic activity decline, with lower sales volumes and cash flows, with those directly exposed to retail sales most affected," added Laura Acres, a Managing Director in Moody's Corporate Finance Group.

According to Moody's, the demonetisation will disrupt economic activity, resulting in temporarily weaker consumption and GDP growth in the immediate term.

However, 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.

Implementation challenges, in addition to affecting growth and government revenues, will affect corporates by lowering sales volumes and cash flows, the report said.

In the medium term, the impact on the corporates will depend on how quickly liquidity returns to the system and transaction flows are restored.

The government could prevent the same amount of cash returning into the system, in an effort to increase the use of non-cash transactions and digital payments.

This 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.

Consumption in India is still largely cash-driven and a move towards digital payments would require a likely gradual change in consumer habits.

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 one-two per cent as a result of the demonetisation -- could lower lending rates, a positive for the 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 the ability of borrowers to repay loans, in particular the 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 customers have a limited ability to withstand a sustained period of economic weakness.

These same factors will also drive delinquencies in securitisation transactions.

Indian auto asset-backed security (ABS) transactions in particular are mainly backed by loans extended to individual entrepreneurs that predominantly transact in cash, Moody's said.

--IANS

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