Moody’s report on note ban in India

• According to Moody's Investors Service, the shock ban on high-denomination currency notes will in the near term significantly disrupt economic activity and lead to weaker GDP growth, but in the long run can boost tax revenues and translate into faster fiscal consolidation.

Highlights:

• 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.
• 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.
• 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.
• This move is affecting all sectors of the economy to various extents, with banks being the key beneficiary.
• In the nearer term, however, the asset quality will deteriorate for banks and non-bank finance companies, as the economic disruption will significantly impact the ability of borrowers to repay loans, in particular for the loans against property, commercial vehicles 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.
• 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.
• Corporates will see economic activity decline, with lower sales volumes and cash flows, with those directly exposed to retail sales most affected.
• Implementation challenges, in addition to affecting growth and government revenues, will affect corporates by lowering sales volumes and cash flows.
• In the medium term, the impact on businesses 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.
• However, consumption in India is still largely cash-driven, and a move towards digital payments would require a likely gradual change in consumer habits.

By: Vishal