Positive impact of demonetisation not 'strong' enough, says Fitch

Though the demonetisation of high denomination currency has the potential to raise government revenue, but at the same time, the positive effects are unlikely to be 'strong', a report said.

Fitch Ratings in its report said that the ban notes, which accounted for 86% of the value of currency in circulation, has created cash crunch and is holding back economic activity. 

Following the announcement, the consumers have not had the cash to complete purchases, and there have been reports of supply chains being disrupted and farmers unable to buy seeds and fertiliser for the sowing season. Also, the time spent queueing in banks is also likely to have affected general productivity, the report said.

Considering the above factors, the rating agency believes that its impact on Gross Domestic Product (GDP) growth will increase, if the disruption continues. Having mentioned that, the agency said it will revise down their GDP forecasts.

Giving reasons for it, the report said that the aim for withdrawing the notes was to curb black money, which is in line with government's agenda. The informal sector accounts for over 20% of GDP and 80% of employment. 

But, with the introduction of Rs 2000 notes, people in informal sector, will still be able to use the new high-denomination bills and other options (like gold) to store their wealth. In the current ongoing exercise by the government, there are no new incentives for people to avoid cash transactions. Thus, the informal sector may go back to business as usual, the report said.

The rating agency believes that there are similar uncertainties over the impact on the banking sector. Saswata Guha, Director, Fitch Ratings, in a note titled 'India Demonetisation Fallout Offset by Uncertain Benefits', said, "Demonetisation could also affect the ability of borrowers in sectors that rely on cash transactions to service their loans, with negative effects on bank asset quality, which is why the RBI has temporarily allowed banks to give small borrowers more time to repay loans before classifying them as non-performing".

Moreover, though there are positive impacts on funding conditions as banks are reporting large increase in deposits since the day of announcement, but there is no policy to prevent them withdrawn again later.

With the effects of demonetisation, reflecting the fragile standalone position of state banks and the absence of larger capital injections, Fitch Ratings reaffirmed 'negative' outlook on India's banking sector.