Notes Ban: Fitch cuts India's FY17 growth forecast to 6.9%

Fitch Ratings on Tuesday lowered India's gross domestic product (GDP) growth forecast for the current fiscal to 6.9% from 7.4%, saying there will be "temporary disruptions" to economic activity post demonetisation.

It said economic activity will be hit in the October-December quarter because of the cash crunch created by withdrawal and replacement of Rs 500 and Rs 1,000 notes that accounted for 86% of the value of currency in circulation.

"Indian growth has also been revised down to reflect temporary disruptions to activity related to the Reserve Bank of India's (RBI) surprise demonetisation of large-denomination bank notes," Fitch said, as it revised real GDP growth forecast down to 6.9% for 2016-17, from 7.4% projected earlier.

The US-based ratings agency also revised GDP growth forecast for 2017-18 and 2018-19 lower to 7.7% from 8% earlier.

"Gradual implementation of the structural reform agenda is expected to contribute to higher growth, as will higher real disposable income, supported by an almost 24% hike in civil servants' wages.

"But the anticipated recovery in investment looks a bit less certain in light of ongoing weakness in the data," Fitch said in its 'Global Economic Outlook - November' report.

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Regarding currency ban, it said consumers do not have the cash needed to complete purchases, and there have been reports of supply chains being disrupted and farmers unable to buy seeds and fertiliser for the sowing season.

"Time spent queueing in banks is also likely to have affected general productivity. The impact on GDP growth will increase the longer the disruption continues," Fitch said, adding the medium-term effect of the currency withdrawal on GDP growth is uncertain, but is unlikely to be large.

"Most importantly, demonetisation is a one-off event. People who operate in the informal sector will still be able to use the new high-denomination bills and other options (such as gold) to store their wealth," it added.

Fitch said there are no new incentives for people to avoid cash transactions and the informal sector could soon go back to business as usual.

Post the demonetisation announcement on November 8, the government and banks have been taking several steps to push digital transactions.

Fitch said it expects RBI's 1.50% policy rate cuts since the beginning of 2015 to feed through to higher GDP growth, even though monetary transmission has been impaired by relatively weak banking sector health.

"A surge in low-cost funding due to the demonetisation may remove a constraint on banks that prevented lending rates from keeping pace with the RBI's policy rate cuts in recent years, although this will depend on deposits remaining in banks beyond the next few months," it said. 

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