Scrapping of Rs500, Rs1000 notes may lower Q3 GDP growth: India Ratings

According to credit rating agency India Ratings, the impact of demonetization on the economy will be felt in the third quarter but the system is likely to readjust thereafter


A file photo of new purple-clad Rs2,000 currency note. Photo: Indranil Bhoomik/Mint
A file photo of new purple-clad Rs2,000 currency note. Photo: Indranil Bhoomik/Mint

Mumbai: The sudden decline in money supply and simultaneous rise in bank deposits post demonetization is going to adversely impact consumption in the economy in the short term and may lead to a lower GDP growth rate, says a report.

According to credit rating agency India Ratings (Ind-Ra), the impact of demonetization on the economy will be felt in the third quarter of the current fiscal, but the system is likely to readjust thereafter.

The government in a surprise announcement had made notes of Rs 500 and Rs1,000 invalid as legal tender from mid-night of 8 November. “The sudden drop in money supply and simultaneous rise in bank deposits is going to adversely impact consumption demand in the economy in the short term,” Ind-Ra said. “This coupled with adverse impact on realty and informal sectors may lead to lowering of GDP growth,” it added.

However, the agency has for now maintained its GDP forecast for the current fiscal at 7.8%. Ind-Ra said the move will significantly eliminate black money and benefit the economy in the medium to long run. While noting that the key segments of the economy where cash transactions play a vital role are realty/construction, gold and the informal sectors, the report said currency dealings in real estate and gold are mostly dubious. But the same is a lifeline for informal sectors.

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“Small and marginal farmers in fruits and vegetable category typically require offloading of their produce in local mandi in cash and may see an immediate impact... though the impact will diminish over time,” Ind-Ra said.

On the financial side, Ind-Ra said a large amount of cash in circulation could be brought within the purview of the formal banking system by way of deposits. “This is structurally a positive for banks as part of this cash gets deposited in current and savings account, reducing banks’ dependence on higher cost borrowing,” it said.

“Deposit deployment remains a challenge in the short to medium term due to the current tepid demand for credit, thus pushing deposit rates lower,” it added. Interestingly, it said that a surge in deposits will create more demand for government bonds and other high-rated bonds in a situation of tepid demand for credit, leading to lower bond yields, especially in the shorter end of the curve.

Among others, the report also said the demonetization could impact the consumption sectors as registered prices in real estate may rise and auto secondary sales may fall. Slowdown in discretionary spending could hurt consumer durables and demand for gems and jewellery could decline and there could be a fall in high-end retail demand.

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