India's demonetisation has mixed impact on sovereign, banks and corporates: Moody's

India Infoline News Service | Mumbai | November 25, 2016 09:21 IST

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.

Moody's Investors Service says that the move by the Government of India (Baa3 positive) to withdraw all Rs 500 and Rs 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 -- Demonetisation Is Beneficial for Indian Government and Banks; Implementation Challenges Will Disrupt Economic Activity".

In the immediate period following the government's November 8 decision, Moody's says the withdrawal of the Rs 500 and Rs 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 demonetisation 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.
 

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