Fitch Ratings has downgraded India's growth to 6.9 per cent for 2016-17 from the earlier 7.4 per cent due to "uncertainty" over the benefits of demonetisation.
"The demonetisation of large denomination bank notes has caused short-term disruption in India's economy and led us to downgrade our growth forecasts for 2017," Fitch Ratings said in its latest bi-monthly newsletter released on Tuesday.
"The move has some potential benefits, but the positive effects are unlikely to be strong or last long enough to make a significant difference to government finances or medium-term growth prospects.
"The impact on the economy will increase the longer the disruption continues, but Fitch has already revised down its GDP growth forecast for the financial year ending March 31 to 6.9 per cent from 7.4 per cent," it said.
The move has the potential to raise government revenue and encourage bank lending, but Fitch Ratings believes the positive effects were unlikely to be strong and sufficiently enduring to support credit profiles, it said.
"The withdrawal of bank notes has left consumers without the cash needed to complete purchases and farmers without the funds to buy seeds and fertilizer for the sowing season. Supply chains have been disrupted and time spent queueing in banks has meant lost hours of productive work," the newsletter said.
Though the intentions behind demonetisation were positive and in keeping with broader reform efforts, the short-term pain may outweigh the uncertain long-term gains, Fitch said.
Government finances may also benefit from a proportion of high-denomination notes not being traded. This potentially significant amount would be subtracted from the Reserve Bank of India's (RBI) liabilities and the authorities would have the option to transfer this windfall to the government.
Fitch, however, said there were considerable uncertainties over the potential positive effects.
"Most importantly, demonetisation is a one-off event. People that operate in the informal sector will still be able to use the new high denomination bills and other options (like gold) to store their wealth. There are no new incentives for people to avoid cash transactions," it said.
"The informal sector could soon go back to business as usual," it added.
There are similar uncertainties over the impact on the banking sector. While some banks have already reported large increases in deposits since demonetisation began, a surge in low-cost funding might encourage credit growth and support the economy.
"The positive impact on funding conditions will depend on deposits remaining in banks beyond the next few months. There is nothing to prevent them being withdrawn again," the newsletter said.
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