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24 Nov 2016
Singapore, November 24, 2016 -- Moody's Investors Service says that the move by the Government of
India (Baa3 positive) to withdraw all INR500 and 1,000 notes --
approximately 86% of all outstanding notes -- 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 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," says 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," adds Laura Acres, a Managing Director
in Moody's Corporate Finance Group.
Moody's conclusions are contained in its just-released report
"Indian Credit -- Demonetization Is Beneficial for Indian Government
and Banks; Implementation Challenges Will Disrupt Economic Activity".
In the immediate period following the government's 8 November decision,
Moody's says the withdrawal of the INR500 and 1,000 notes
will significantly disrupt economic activity, resulting in temporarily
weaker consumption and GDP growth.
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.
In addition, 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 formalization 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.
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
1%-2% as a result of the demonetization -- 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 in 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 customer have a limited ability to withstand a sustained period
of economic weakness.
These same factors will also drive delinquencies in securitization transactions.
Indian auto asset-backed security (ABS) transactions in particular
are mainly backed by loans extended to individual entrepreneurs that predominantly
transact in cash.
In the longer term, like banks and corporates, Moody's
expects the reduced reliance on cash in the Indian economy will benefit
auto ABS transactions, because it will reduce the need for high-touch
servicing, increase the predictability of payment collections and
improve the ability of lenders to assess borrowers' credit profiles.
Subscribers can access the report at:
http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_1051019
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