India’s note-ban, GST reforms likely to be beneficial in the long-run, says S&P Global Ratings

India's corporates and banks are likely to face short-term downside risk as a demonetization-related cash crunch curbs the country's GDP growth, according to S&P Global Ratings. The ratings agency recently revised down its estimated economic growth rate for the fiscal year ending March 31, 2017, by one full percentage point, to 6.9 percent, to reflect the disruption caused by the surprise move of demonetization.

The Indian government's decision to strip the legal tender status of large Indian rupee notes has caused a significant physical cash crunch. Both the demonetization and a goods and service tax (GST), which is 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.

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.

"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 pressurized at the margin. Digital banking and higher banking base could benefit the banks in the long run," said Geeta Chugh, Credit Analyst, S&P Global Ratings.

Meanwhile, demonetization 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. 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, the report added further.