Hitting the High Notes

The government´s move to demonetise old Rs.500 and Rs.1,000 banknotes has been widely hailed by the country´s infrastructure sector as a positive development. Industry representatives would also like the government and its agencies to simultaneously roll out adequate measures to counter any likely bumps on the road ahead.

The Prime Minister Narendra Modi-led National Democratic Alliance (NDA) government´s surprise November 8 ´surgical strike´ on the black economy will have a short-term impact on the infrastructure sector. The after-effects of the move are likely to start petering out in the medium to long-term, a cross-section of industry experts told INFRASTRUCTURE TODAY.

´I would like to believe that it would take a quarter (for the recovery to happen). After three months, the situation will start returning to normal,´ opines Vinayak Chatterjee, Chairman & Co-Founder of the Gurugram-headquartered infrastructure services firm, Feedback Infra.

Positive Overall Move
Avers Harshvardhan Neotia, President of the industry lobby group FICCI, ´The move to demonetise Rs.500 and Rs.1,000 currency notes could lead to a temporary squeeze on liquidity. Amidst this scenario it remains critical that both the government and the Reserve Bank of India (RBI) take measures to counter any downside impact on economic activity.´ Neotia has further urged the central bank to continue with an accommodative stance, support the sentiment of investors and consumers, and stabilise demand.

According to Chatterjee, presently three areas of the infrastructure sector are most affected: roads & highways, power distribution companies and real estate construction firms. In roads & highways, the immediate impact has been somewhat noteworthy because for a few weeks following the decision, toll collection came to a standstill. This has resulted in throwing revenue projections and cash flows of most build-operate-transfer (BOT) operators out of gear. ´However, the National Highways Authority of India (NHAI) has said it will compensate the BOT operators. First it said, it will compensate in cash, but increasingly we are beginning to feel that it will compensate by elongating the concession period. In the medium-term, there is uncertainty as to what the internal rate of return (IRR) for projects will be because they are now going out of sync with the projections. In the medium or long-term, it gives a huge degree of push to electronic toll collection,´ he says.

In the power sector, the short-term impact has been on power distribution companies. A few power players in the field witnessed a surge in their cash collection in the immediate aftermath of demonetisation. But that is more of a passing phase. ´Again, in the medium to long-term, the power distribution companies are also being pushed towards more banking-related transactions and less cash. The impact on the power sector is mostly to do with power distributors and consumer collections because the big clients anyway make cheque payments,´ points out Chatterjee.

In Chatterjee´s view, it is the construction sector that is the hardest hit. That value chain works from the principal contractor to sub-contractor to sub-sub-contractor. And there´s lot of cash right through the system where entire value chains have collapsed. ´The short-term impact has been a break in the cash value chain, particularly, in smaller civil contracts because of the chain of contractors and sub-contractors breaking down. Also, a lot of miscellaneous outsourced functions such as riveting, welding and cable laying are paid in cash. That has had an immediate impact on construction activity. The uptick is going to take some time to return in the medium-term as there is excess stock anyway in the market. But everything will be positive in the long-term,´ he asserts.

The Analyst´s Take
According to the report Indian Credit: Demonetization Is Beneficial for Indian Government and Banks; Implementation Challenges Will Disrupt Economic Activity released by Moody´s Corporation´s bond rating credit arm, Moody´s Investors Service, in late November, the decision by India to withdraw specific old high denomination banknotes accounting for over 86 per cent of all outstanding legal tender, will benefit government and banks.

´Although the measures in the near term will pressure GDP growth and thereby government revenues, in the longer term they should boost tax revenues and translate into higher government capital expenditure and faster fiscal consolidation,´ says Marie Diron, Associate Managing Director, Moody´s Sovereign Group, in a statement from Singapore.

´Corporates will see economic activity decline, with lower sales volumes and cash flows, with those directly exposed to retail sales most affected,´ adds Laura Acres, Managing Director in Moody´s Corporate Finance Group.

In the immediate period following the government´s decision, the withdrawal of old banknotes will cause notable interruption to economic activity, resulting in temporarily weaker consumption and GDP growth.

However, greater formalisation of economic and financial activity would ultimately help broaden the tax base and expand usage of the financial system, which would be credit positive. Implementation challenges, in addition to impacting growth and government revenues, will affect corporates by lowering sales volumes and cash flows. In the medium-term, the impact on the corporates will depend on how quickly liquidity returns to the system and transaction flows restored. The government could curtail the same amount of cash returning into the system, in its bid to encourage non-cash transactions and digital payments. Although this would help improve the overall operating environment for doing business in India by improving the ease and speed at which payments reach manufacturers and reducing corruption, it may simultaneously prolong the economic disruption.

Since consumption in India is largely cash-driven, the Moody´s report cautions that a move towards digital payments would require a likely gradual change in consumer habits. Banks would benefit significantly from a move towards digital payments, given their role as intermediaries for such transactions. Additionally, increase in bank deposits by 1 to 2 per cent as a result of the demonetisation, could lower lending rates. In the nearer term, however, Moody´s expects asset quality to deteriorate for banks and non-banking finance companies (NBFC), as the economic disruption impacts the ability of borrowers to repay loans against property, commercial vehicle and micro-finance sectors.

A Giant Leap of Faith
Senior economist Professor Arun Kumar has pegged the size of India´s black economy at 60 per cent of the GDP. Therefore, India´s decision to demonetise, if successful, will deal a fatal blow to the black economy and help improve business climate through transparency in the economy. Therefore, despite the challenges of implementation that are likely to interrupt economic activity in the short and medium-term, it is a giant leap of faith at this moment.

– MANISH PANT