Demonetisation to significantly disrupt economic activity in short term: Moody’s

Moody’s says demonetisation will lead to weaker growth in near-term, though in long run it can boost tax revenues and translate into faster fiscal consolidation


Moody’s said the move to ban old Rs500 and Rs1,000 banknotes is affecting all sectors of the economy to various extent, with banks being the key beneficiaries. Photo: Bloomberg
Moody’s said the move to ban old Rs500 and Rs1,000 banknotes is affecting all sectors of the economy to various extent, with banks being the key beneficiaries. Photo: Bloomberg

New Delhi: Demonetisation will “significantly disrupt economic activity” and lead to weaker growth in near-term, though in the long run it can boost tax revenues and translate into faster fiscal consolidation, Moody’s Investors Service said on Thursday.

In a report titled ‘Indian Credit — Demonetisation Is Beneficial for Indian Government and Banks; Implementation Challenges Will Disrupt Economic Activity’, Moody’s said the move to ban old Rs500 and Rs1,000 notes is affecting all sectors of the economy to various extent, with banks being the key beneficiaries.

“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,” Moody’s Sovereign Group Associate MD Marie Diron said.

Moody’s added 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.

In the immediate period, demonetisation would “significantly disrupt economic activity, resulting in temporarily weaker consumption and GDP growth,” it maintained.

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.

“Corporates will see economic activity decline, with lower sales volumes and cash flows, with those directly exposed to retail sales most affected,” Moody’s Corporate Finance Group MD Laura Acres said.

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, it added.

In a report, S&P Global Ratings too said demonetisation would be positive in long-term, but will have a transitory impact on growth in the short run and could hurt banks’ asset quality.

“Bank deposits would benefit due to demonetisation, though not all inflows will remain in the banking system on a permanent basis,” S&P said.

On 8 November, Prime Minister Narendra Modi announced demonetisation of Rs500 and Rs1,000 banknotes, thereby withdrawing 86% or Rs14 lakh crore worth currency from circulation.

READ MORE