In the long run, demonetisation and the GST could result in a wider tax base and greater participation in the formal economy, says global rating agency S&P.

S&P says that as per it’s base case scenario, the disruption from demonetisation should be short-lived with demand revival in the next one to two quarters, limiting the impact on Indian banks and corporates. Photo: Mint

New Delhi: Indian banks and companies face short-term downside risks due to the cash crunch arising from the government’s decision to invalidate old high-value currency notes, but the move will be beneficial for the Indian economy in the long run, global rating agency S&P said on Wednesday.

“Indian government reforms will have long-term structural benefits but carry short-term execution and adjustment risks,” S&P Global Ratings credit analyst Abhishek Dangra said in an article titled India’s Demonetization And The GST: Short-Term Pain For Long-Term Gain.

It pointed out that the Narendra Modi government’s decision to demonetise Rs500 and Rs1,000 currency notes with effect from 9 November had led to a significant cash crunch in the economy.

S&P expects both demonetisation and the goods and services tax (GST) to adversely impact some sectors of the economy in the short run but have long-term benefits. It had recently revised it’s growth forecast for India to 6.9% in 2016-17 from 7.9% earlier.

“Both the demonetisation and a goods and service tax (GST) expected to be implemented by September 2017 are likely to have a higher disruptive impact on the informal, rural, and cash-based segments of the economy,” it said.

However, in the long run, demonetisation and the GST could result in a wider tax base and greater participation in the formal economy. This should benefit India’s business climate and financial system in the long run, the rating agency said.

S&P says that as per it’s base case scenario, the disruption from demonetisation should be short-lived with demand revival in the next one to two quarters, limiting the impact on Indian banks and corporates.

However, in the short term, the rural and informal sectors of the economy are experiencing large-magnitude adjustments. Business sectors that often transact in cash, including jewelry and real estate, will also face some degree of upheaval, S&P said.

It added: “In a less-likely downside scenario, the shock of demonetization will not be absorbed within the next few months and the economic disruption will spill over into fiscal 2018, and potentially coincide with the introduction of the GST. Economic growth will stay lower for longer, raising stress levels on corporates, banks, and other financial institutions; although the sovereign rating is likely to remain resilient.”