Talking Point: Reforms to help India in long run

S&P Global Ratings recently revised down its estimated economic growth rate for the fiscal year ending March 31, 2017, by one full percentage point, to 6.9 per cent, to reflect the disruption caused by the surprise move of demonetisation. The Centre’s decision to strip the legal tender status of large Indian rupee notes has caused a significant physical cash crunch. 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. 

“We expect lower private consumption in fiscal 2017, but expect demand to revive and growth to rebound in fiscal 2018. India should shortly revert back to an 8 per cent annual growth trajectory,” says Dharmakirti Joshi, Chief Economist of Crisil, the India-based subsidiary of S&P Global. In our base case, we expect a short-lived disruption with demand revival in the next one to two quarters, limiting the impact on Indian banks and corporates. In the short term, the rural and informal sectors are experiencing large-magnitude adjustments. Business sectors that often transact in cash, including jewellery and real estate, will also face some degree of upheaval. We have assessed the likely impact on key corporate sectors in our detailed report. 

“The banking sector will face marginally negative pressure in the short run as loan growth will remain soft, and asset quality and earnings will be pressurised at the margin. Digital banking and higher banking base could benefit the banks in the long run,” said S&P Global Ratings credit analyst Geeta Chugh. 

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. 

S&P Global Ratings believes that demonetisation and 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.