India’s revenues likely to rise on better tax compliance; RBI to maintain neutral liquidity stance

India is expected to witness a boost in its revenues, following a widening in the tax base and better tax compliance, along with the potential for a one-off dividend payout by the Reserve Bank of India (RBI). A flush in liquidity will aid improvement in the monetary transmission mechanism, thus leading to lower lending rates. This will also likely enable the Reserve Bank of India (RBI) to maintain neutral liquidity without having to resort to Open Market Operations (OMOs).

Depending on the intensity of withdrawals by the public, banking liquidity is expected to rise anywhere between INR1.5-3.5 trillion, ANZ reported.

India’s highest denomination currency notes of INR500 and INR1000, which together account for 85% of the currency in circulation, ceased to be legal tender from 9 November, following a surprise move by the government to curb the menace of black money and counterfeit notes.

Despite the short term negative effects on consumption, especially consumer durables, and cash intensive sectors such as real estate and cement, we believe the demonetization move is expected to be ground-breaking.

In the short term, inflation would remain benign due to negative effects on activity. Over the medium to longer term, however, the net impact on inflation is expected to be neutral as income and demand will improve due to higher public spending.

Meanwhile, additional fiscal space will allow the government to remain committed to fiscal rectitude, thus ensuring that inflation remains on the RBI’s projected path.