- May affect economic activity in the short term
In ICRA’s view, the withdrawal of legal tender status for the existing currency notes in the denominations of Rs. 500 and Rs. 1,000 would help to curb illegal transactions and reduce the incidence of black money, which are positives in the long term. However, there would be some temporary disruption to legal transactions that are normally conducted in cash, which may impact economic activity.
Aditi Nayar, Senior Economist, ICRA Limited, said: “In the immediate term, legal transactions in the unorganised sector may get temporarily disrupted, particularly in rural areas. While the Q3 FY2017 GVA growth was expected to be robust at around 7.8% on the back of improved rural and urban consumption during the festive season, the intermittent disruption to activity in some sectors may result in economic growth being modestly lower than expected.”
Some crucial sectors of the economy, where there is a sizeable magnitude of cash transactions, such as Real Estate, Construction, Jewellery, High-end Retail, and Travel & Tourism, could also be adversely affected.
Additionally, Micro Finance Institutions and NBFCs focused on retail lending may see some issues in cash collections. All this could lead to a modest slowdown in economic activity over the next few quarters.
In the past, election spending that was predominantly in cash, used to provide a short-term stimulus to economic activity, the impact of which would be limited in the Legislative elections expected to be conducted in some states in early 2017.
Karthik Srinivasan, Senior Vice President, ICRA Limited, said: “Deposit mobilisation is expected to rise considerably, as existing notes are deposited in banks, helping to counter balance the outflows related to the unwinding of the FCNR(B) swaps. As a result, deposit growth could rise significantly in the next two months, from the low double-digit level at present. This would also aid transmission of past repo rate cuts to reduction in the MCLR rates. Nevertheless, we do not expect a major pickup in bank credit growth, given the sharp and immediate correction in bond yields that has already taken place.”
Higher deposit mobilisation in the ongoing quarter would improve systemic liquidity, reducing the need for open market bond purchases during Q3 FY2017 to bring liquidity closer to neutral. However, such liquidity would not be durable, and therefore, we continue to expect open market bond purchases during Q4 FY2017.
Moreover, this scheme may help to bring forth previously unaccounted for income into the formal channels, which would provide some boost to the Government of India’s (GoI’s) tax collections. Previously, income in excess of Rs. 65,000 crore was declared under the Income Disclosure Scheme of the GoI, which closed on September 30, 2016.
The demonetisation of Rs. 500 and Rs. 1,000 notes was expected to negatively impact the INR. However, in light of the volatility in global financial markets and weakness of the US$ subsequent to the US election results, the impact on the INR-US$ pair is expected to be relatively muted compared with other currencies. ICRA expects the INR-US$ pair to trade in a range of 66.0-68.5 in the remainder of this fiscal year.
