Moody's Investors Service expects Indian economic growth to continue to pick up as liquidity conditions normalize, supporting expectations that the economic disruption caused by demonetization will be short term in nature.

Moody's conclusions were contained in its just-released report on Indian credit, "Economic Slowdown from Demonetization Wanes; Credit Implications Unfolding".

The Indian government (Baa3 positive) announced its demonetization measures on 8 November 2016 with the withdrawal of all INR500 and INR1,000 notes, or approximately 86% of the banknotes in circulation by value.

The Moody's report provides an update on the implementation of demonetization and subsequent remonetization, the impact on the economy, and the credit implications for the government, companies, banks and the structured finance market.

The recovery in the total stock of currency in public circulation, which had declined from about INR17 trillion before demonetization to a low of INR7.8 trillion in early December, before rebounding to about INR9.8 trillion in early February 2017, illustrates this incremental improvement in liquidity. Looking ahead, we expect remonetization to continue at a similar pace.

Moody's expects GDP growth to moderate to about 6.4% in the January to March 2017 quarter from 7.0% in the October to December 2016 quarter, before picking up above 7.0% thereafter, as the temporary drag from demonetization fades.

Moody's further notes that sales in India's real-estate and auto sectors are gradually recovering after falling sharply in the immediate aftermath of demonetization and expects the trend to continue over the second half of this year.

Steel production also took a substantial hit following demonetization, but has rebounded quickly and is currently performing better than anticipated. Meanwhile, demonetization has had little impact on India's rated oil and gas refining and marketing companies, in line with Moody's prior expectations.

On the other hand, the slowdown in economic activity has weighed on demand for credit among retail borrowers. We expect this trend to continue over the next few months and for asset quality to deteriorate in the current quarter, although Indian banks have sufficient buffers to withstand the impact.

The banks have experienced significant deposit inflows as a result of the canceling of the INR500 and INR1,000 notes. Overall, however, we expect that bank deposits will increase by only around 1% to 2%, compared to before demonetization, with cash remaining the dominant means of retail transactions.

With the structured finance market, the performance of rated Indian auto asset backed securities (ABS) leveled off in January 2017, after deteriorating immediately after demonetization. We expect delinquencies and collections to return to pre-demonetization levels by the end of March 2017 as the economy recovers, and as stronger oil prices and budget policy initiatives provide support.

In addition, Moody's believes that the government's reform agenda remains on track, supported by a prudent budget. Progress on the pending Goods and Services Tax (GST) reform and Finance Minister Arun Jaitley's 2017 budget speech to parliament both underscore the government's commitment to reform in the wake of demonetization.

Finally, Moody's continues to believe that in the medium term, demonetization will strengthen India's institutional framework by reducing tax avoidance and corruption, a credit positive for the sovereign.

In this context, the government's revenues may benefit if the old notes that are deposited into the banking system provide information about economic activity that can be used to enhance tax collection in future.