The government’s sudden move to demonetise ₹500 and ₹1,000 currency notes will have a transitory impact on GDP growth.
According to research by ratings agency CRISIL, the new decision will spell significant strutural benefits over the long term.
In the longer run, this move will improve the government’s fiscal position and tax compliance.
CRISIL is a global analytical company providing Ratings, Research and Risk & Policy Advisory services.
Inflation is expected to drop as demand slows in the short-term but the impact over the long-term would be neutral.
– Government revenues should see buoyancy in the medium-to-long term
The direct positive impact will be felt on government’s tax revenue collections, its ability to spend on infratructure investments and the resultant impact on growth. In the long run, as the government spending rises pushing up employment and incomes, demand wil revive.
– Tax to GDP ratio can improve materially
Income tax collections are expected to see a kick-up as funds earlier unaccounted for enter the banking system and eventually get taxed. The one-time impact on tax collections could be high. However, in the longer run, better tax compliance and some initial disincentive to hoard cash could push up direct collections in the medium term.
The Income Declaration Scheme of the government which ended in September is expected to add around ₹300 billion to direct tax collections over fiscals 2017 and 2018.
– Public investments to rise and drive jobs and income
Higher tax collections will now allow the government to further increase such spending. Higher direct tax collections will now alow the government to further increase such spending.
Putting that to perspective, value of cash transactions, according to a 2013 report, percentage of total consumer payments was approximately 86% in 2012.
– Tax rates could edge lower
Higher income collections arising from better compliance would also offer scope to reduce income tax rates over the long term, which would increase disposable incomes. This can have a positive impact on comsumption demand in the long term.
– Downward pressure on inflation
Categories such as housing, transport and food that tend to have a higher cash component could see downward price pressures in the coming months as demand is negatively affected.
Rural areas which have a higher share of cash transactions could see a dip in inflation comparedwith urban in most categories.
The impact on inflation is expected to be neutral in the medium-to-long term.