The benefits of the demonetisation of Rs 500 and Rs 1,000 notes could be uncertain, said a report by Fitch Ratings titled “2017 Outlook: Indian Banks”. The report said that the discontinuation of the large denomination notes has led to a short-term disruption in India’s economy. The withdrawal of bank notes has created a cash crunch, with the time spent queuing up outside banks affecting general productivity.
The positive effects of demonetisation move are unlikely to be strong, the report said. “The move has the potential to raise government revenue and encourage bank lending, but Fitch Ratings believes the positive effects are unlikely to be sufficiently enduring to support credit profiles.”.
Moreover, the impact on Gross Domestic Product growth will increase the longer the economic disruption caused by the move goes on, the report said. The October-December 2016 quarter “will almost certainly” be weak as the impact on GDP growth continues, Fitch added.
The move by the government could also affect sectors that rely on cash transactions and have a negative impact on bank asset quality. “Most importantly, demonetisation is a one-off event. People that operate in the informal sector will still be able to use the new high-denomination bills and other options (like gold) to store their wealth.”
However, the move was also likely to affect borrowers operating in sectors that rely on cash to service their loans. While the move had led to a surge in deposits, it was unclear if the money would remain with banks and not be reintroduced into the market. This is likely to have an effect on “funding conditions“, which will depend on “deposits remaining in banks”.
“Finally, there are other factors holding back lending, most notably the under-capitalisation of state-owned banks and weak investment demand,” the report added.
The country has been grappling with a cash crunch since the Centre demonetised the high-value currency notes. The Supreme Court had observed that the long queues seen outside banks since the move was announced was a serious problem that could even lead to riots. The surprise decision has met with massive criticism from Opposition parties. The Congress has accused the government of introducing “financial anarchy” in the country.