Fitch added that the RBI policy rate cuts by a total 150bp since the beginning of 2015 are likely to feed through to higher GDP growth.
"Economic activity will be hit in Q4 FY17 by the cash crunch created by withdrawal and replacement of bank notes that account for 86% of the value of currency in circulation," the rating agency said in a report.
The demonetisation of large-denomination bank notes has caused short-term disruption in India's economy. The move has the potential to raise government revenue and encourage bank lending, but Fitch Ratings believes the positive effects are unlikely to be strong and sufficiently enduring to support credit profiles.
Consumers have not had the cash needed 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. Time spent queueing in banks is also likely to have affected general productivity. The impact on GDP growth will increase the longer the disruption continues, but we will already need to revise down our forecasts to reflect what will almost certainly be a weak Q4 FY17.
The move could boost government revenue to the extent that demonetisation helps to move economic activity from the informal to the formal sector, as more earnings would be declared. It is possible that this positive effect would soon outweigh the drag on revenue collection from lower short-term GDP growth.