The temporary disruptions (primarily to private consumption) caused by cash shortages accompanying the currency exchange initiative are expected to gradually dissipate in 2017 as cash shortages ease, the International Monetary Fund said in its regional economic outlook.
Such disruptions would also be offset by tailwinds from a favourable monsoon season and continued progress in resolving supply-side bottlenecks, the IMF said.
The investment recovery is expected to remain modest and uneven across sectors as deleveraging takes place and industrial capacity utilisation picks up, it noted.
"In India, growth is projected to rebound to 7.2 per cent in FY2017-18 and further to 7.7 per cent in FY2018-19," the IMF said.
"Headwinds from weaknesses in India's bank and corporate balance sheets will also weigh on near-term credit growth.
Confidence and policy credibility gains, including from continued fiscal consolidation and anti-inflationary monetary policy, continue to underpin macroeconomic stability," the IMF said.
The IMF maintains a positive outlook on the Indian economic growth and is confident that the Goods and Services Tax (GST) implementation will be smooth.
"India is one of the countries that have excellently performing reforms and that is one of the major reasons for the country to maintain one of the highest economic growth rates (in the world)," said Changyong Rhee, director for Asia and Pacific Department at IMF at a press conference in Singapore after presenting Asia and Pacific Regional Outlook report.
Touching on GST, he said, "We have been working very closely with India in preparing the introduction of GST. I am very confident that India has prepared the GST introduction in the past couple of years."
He pointed out that implementation of such tax system remains very challenging especially preparation of system integration between the government and the business sectors.
He stressed that such implementation would not be easy and there would be hiccups, adding that the IT system has to be well prepared and well implemented.
He pointed out that there have been several countries that have implemented GST systems recently.
On other sector's performance, the report noted that following the demonetisation, there has been a massive increase in liquidity in the banking system which can reduce banks' funding costs and lead to a decline in banking lend rates.
But it cautioned about further buildup of non-performing loans, including among private banks and elevated corporate sector vulnerabilities.
It called for ensuring prudent support to the affected economic sectors in the country.
According to the report, growth in Asia is forecast to accelerate to 5.5 per cent in 2017 from 5.3 per cent in 2016.
Growth in China and Japan is revised upward for 2017 compared to the October 2016 World Economic Outlook, owing mainly to continued policy support and strong recent data.
Growth is revised downward in India due to temporary effects from the currency exchange initiative and in South Korea owing to political uncertainty. Over the medium term, slower growth in China is expected to be partially offset by an acceleration of growth in India, underpinned by key structural reforms.
According to the report, in India, improving productivity in the agriculture sector, which is the most labour-intensive sector and employs about half of Indian workers, remains a key challenge.
More needs to be done to address long-standing structural bottlenecks and enhance market efficiency, including from liberalising commodity markets to giving farmers more flexibility in the distribution and marketing of their produce, which will help raise competitiveness, efficiency, and transparency in state agriculture markets, it said.
In addition, input subsidies to farmers should be administered through direct cash transfers rather than underpricing of agricultural inputs, as such subsidies to the agriculture sector have had large negative impacts on agricultural output, IMF said.