Demonetisation or no demonetisation, the state of public sector banks in India is still fragile unless they receive adequate capital injection to meet Basel-III norms, according to Fitch Ratings.

In a report, the agency said: “The move has the potential to raise government revenue and encourage bank lending, but Fitch Ratings believes the positive effects are unlikely to be strong and sufficiently enduring to support credit profiles.”

The withdrawal of bank notes accounting for 86 per cent of the money in circulation has created a cash crunch, and held back economic activity with consumers low on cash needed to complete purchases, Fitch observed. The informal sector accounted for over 20 per cent of GDP and 80 per cent of jobs, and with no new incentives for people to avoid cash transactions, the informal sector could soon go back to business as usual using the new high-denomination notes and other options such as gold to store their wealth, Fitch said.

Though India’s sovereign credit profile would benefit due to improving government finances, there were considerable uncertainties over the potential positive effects, the report opined.

Though reduced lending rates due to an increase in deposits would be a reality, the move would affect the ability of borrowers in sectors relying on cash transactions to service their loans, with negative effects on bank asset quality.

Hence, the RBI has temporarily allowed banks to give small borrowers more time to repay loans before classifying them as non-performing, Fitch said, adding that there was nothing to prevent these deposits from being withdrawn again.

These coupled with under-capitalisation of state-owned banks and weak investment demand will hold back lending, it said, and reaffirmed Fitch’s negative outlook on the banking sector.

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