Confidence in RBI Undermined by Demonetisation: S&P

The government’s reforms will have long-term structural benefits, but carry short-term execution, adjustment risks.

As the RBI abolished the Rs 500 and Rs 1,000 notes a month ago, S&P’s Director Kyran Curry said the confidence in the central bank and its independence has been undermined.

He has, however, also said that the bank remains to be a credible institution.

Demonetisation has cast a shadow over the RBI’s competence and independence. We still think this institution is a very credible one, and in terms of the conduct of monetary policy, it’s a very mature institution.

Kyran Curry

In a teleconference with the media, Curry said that the demonetisation undermined confidence in the predictability and effectiveness of policy-making in India, including the RBI.

S&P also said demonetisation and a likely GST rollout from September 2017 can possibly cast a "higher disruptive impact" on informal, rural, and cash-based segments of the economy.

“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 Demonetisation and the GST: Short-Term Pain for Long-Term Gain, published on Wednesday.

The rating agency recently revised downwards its estimated economic growth rate for 2016-17 by one full percentage point to 6.9 per cent to reflect the disruption caused by the surprise move of demonetisation.

Both demonetisation and a goods and services tax are likely to have a higher disruptive impact on the informal, rural, and cash-based segments of the economy.

S&P

The credit and risk analysis firm 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.

We believe such measures can promote greater economic flexibility, strengthen the business climate, funnel more wealth into the formal banking system, and help redress public finances over time. 

Kyran Curry

“India should shortly revert back to an 8 per cent annual growth trajectory,” says Dharmakirti Joshi, Chief Economist of Crisil, a 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, however, the rural and informal sectors are experiencing large-scale adjustments. Business sectors that often transact in cash, including jewellery and real estate, will also face some degree of upheaval.

In a less-likely downside scenario, the shock of demonetisation 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 GST, the US-based agency said.

It added that in a less probable situation, 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.

(With inputs from PTI, Reuters)