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A Detailed Analysis of Demonetisation
The sudden announcement of government to discontinue the use of 500 and 1000 denomination notes w.e.f 8th November midnight was received with applause as well as criticism by many. This demonetisation exercise is not only a big but also a bold step to erode the parallel black money economy that has ailed Indian economy for decades. Many have their concerns around the efficacy of this measure in long term. Yes, it is a step which flushes out black money in a flash and is not sustainable in long run but right now the sentiment in India topples towards “some step is better than no step”. It is also being accepted that FY ending March’17 may show a dip in our GDP. We had earlier published an article on Impact of Demonetisation on Indian economy. In this article we are discussing “Demonetisation” as a measure and its Pros and Cons. Thereafter we will move onto its impact on various economic and industrial sectors of India.
Effects of Demonetisation
We would say that immediate effects of demonetisation are clearly evident and those are more on social level presently. It seems money has simply evaporated and people of all ages and from all social levels are rushing to banks. With estimated 300 million people who do not have any valid id cards (in spite of various government initiatives) and more who do not have access to mobile phones and similar technology, demonetisation in India will face its own challenges. That and the effect of this move on coming elections in the state of UP where political rivals of the ruling BJP, are crying bloody murder. We are covering these and more profound effects on demonetisation.
Reduction in currency circulation
Owing to discontinuation of Rs. 500 and 1000 denomination, a temporary fall in currency circulation is expected and can be seen already. These notes form 86% of total money (in value) minted in India by RBI! With 86% sucked in due to demonetisation, liquidity will obviously take a fall. But this situation will be contained as the new note of Rs. 2000 gets into circulation and bank withdrawals becoming easier. This condition can also lead to temporary deflation and weakening of rupee until the circulation normalises.
Compulsory declaration of undeclared income
The government of India had been strategising this move of demonetisation for quite some time as we look at the initiative it took after it came to power. Right from linking Aadhar cards, encouraging bank accounts opening and then volunteer declaration of income in cases of concealment. Well, the voluntary declaration or IDS ended on 30th September, a scheme that just required tax payers to pay a tax without any legal proceedings or penalties. Well, the time is gone and now to get at least some worth of the hidden cash stash, you will have to go through compulsory declaration which will be taxed and penalised as well.
Introduction of more cash to main stream banking
This step is already taking place but of course due to influx of withdrawals, the real effect of all people turning to mainstream banking channels is still to be seen. It might take months but is sure to happen as every common man would deposit the cash and opt for debit and credit cards.
Automation and organised monitoring of transactions
All banking transactions are obviously monitored because there is a proper digital trail to it. With more account holders post demonetisation, most of the money will get routed through banking channels making it easier for authorities to track illicit transactions. It is pertinent to mention here that banking channels discourage such transactions, thanks to the trail they leave.
Loan rates may come down
The biggest payoff of demonetisation is to create a cashless economy and make people open bank accounts. More than 50% of people in India do not have bank accounts, if this process goes as expected then even after taking a pessimistic view, at least 30% will open bank accounts to deposit money. This should increase the liquidity with banks pushing down the rates on loans as well as deposits.
Drugs and terrorism
It is a well known fact that illegal drugs trade and terrorism run on hawala money. Drop in currency circulation coupled with discontinuation of certain denominations will certainly hamper these operations. According to a well placed report, terrorists use fake Rs. 500 notes to get their operations up and running in India, well the discontinuation should take care of this situation for the time being.
Real estate prices will come down drastically
There has been a lot of talk around real-Estate bubble bursting in India but frankly nothing significant happened on the ground. Yes, the sector had slowed down but urban India still had to shell out big moolah to secure a dream home. So how will demonetisation take care of over hiked and inflated real estate? We will discuss it in detail when we get to sector-wise analysis but in short, a major part of Real Estate, about over 50% dealt on cash transaction to save on tax. With currency gone, the cash transactions will be all but impossible to execute.
Boost to economy
According to a report in Bloomberg, a massive part of currency in India never sees bank which is pegged at about $450 billion and is roughly 1/5th of India’s GDP! The total value of Rs. 500 and 1000 notes in circulation were 14 lakh crore, of which 25-50% remained unaccounted for due to hoarders. Now if this cash comes into circulation, it will surely add to the economic growth of the country and if it does not then too one can be sure that the stash lies useless.
Menace of Fake notes
Over the past two years recovery of fake currency dipped by 30%, reason being high quality of fakes that look and feel almost real. This made the detection very difficult. The highest percentage of fake currency in circulation was of Rs. 500 and 1000 denomination. The discontinuation of these two denominations has already hit the illegal money minting establishments hard including the biggest one in Malda, India.
Replacement of currency is a costly affair
There is no doubt that demonetisation would eventually make India cash rich but as of now, we must point at one big expense it has to incur for replacing the old denomination with new. The cost to RBI is estimated at Rs. 2800 Crores for this entire exercise while the total benefit of demonetisation is pegged at Rs. 2.5 lakh crore. At the net level, this deal is definitely beneficial even if it has its cost.
Presently we can expect almost $3 Trillion of assets to go missing from the RBI Balance sheet owing to black money which will be destroyed and other stashes not tendered to bank. According to the report the percentage that makes up this $3 trillion is assumed at 20% but we assume that it would be higher at about 30% at least. The higher percentage can be assumed because there is a huge chunk of Indian population that does not have access to banking or chooses not to be part of mainstream banking. To balance its books, RBI will have two options – either declare special dividend for government or cancel old debt of government. In both these cases, government is sure to have windfall gains at the cost of RBI!
The GDP question
There is one more aspect we have to look into and that is lost GDP of almost two months! With restricted spending, GDP will surely take a hit. In fact before this move, IMF had given a forecast of impressive 7.6% growth rate to Indian economy. But with recent factors taken together, the GDP of India might contain itself under 6% according to various reports from very many rating agencies. One can only hope to recover the loss when liquidity returns and Indians shop with vengeance!
All those with black money invested outside country would escape unscathed
Now there is one major point on which this step has been criticised which is that bigger fish shall escape this onslaught of making economy clean. And yes, it is true since most of the people making black money usually invest it in assets or push it overseas. More measures complimenting demonetisation will be required to make it a well rounded programme.
Sector-wise Impact of Demonetisation on Indian Economy
In India, broad sector-wise contribution to GDP is- Agriculture (17.9%), Industry (24.2%) and Services (57.9%).Demonetisation will affect various sectors of economy in its own way. An initial slowdown is expected almost everywhere because of low liquidity that would ail Indian economy for sometime. With retail demand falling, the ripples would be witnessed in the industrial sector particularly manufacturing entities.
Banking sector is going to be on a roll with demonetisation. With liquidity increasing and their deposit to loan percentage improving significantly, bank stocks are going to take a high street ride. This move will lend stability and strength to core banking structure. One can also expect generation of employment in this sector as more and more unaccounted cash finds its way into formal banking channels and as discussed earlier, this amount is humongous! Going forward, increased number of banking transactions shall continue to fetch brownies for banking sector.
There are two ways in which financial markets will benefit from this move once the situation stabilises. Many people who hoarded cash would eventually look for new avenues for investments and stock market would be a natural choice. Also, banks are big contributors into financial markets. They invest their reserves and create financial products that are in turn invested into the stock and commodity markets. One can expect that this rush of liquidity would directly impact financial markets positively.
Its true that as soon as the news of demonetisation was announced, all online shopping marts like Snapdeal, Amazon and Flipkart stopped cash on delivery. It may have hurt their sales slightly but very soon these online shopping portals can expect to be on roll. With more and more people joining the formal banking system, online shopping will certainly get a boost. Payment gateways like e-wallet, Paytm and mobile wallets are also going to gain big from this step.
In 2012, finance ministry reported that Real Estate forms 11% of our GDP and unfortunately this is one sector where 50% of the total money that comes in is black. In India, it has become a norm to buy a house partially through bank payments and rest by cash. According to a report by Ambit Capital, Black money in Real Estate is about Rs. 30 lakh crores which is 50% of the total black money! It is the re-sale market that has driven the black money transactions mostly and an imminent fall of 25-30% in luxury home rates.
With already slowing growth, demonetisation is going to hit the sector hard. This move is also expected to rationalise the over-inflated Real Estate sector in coming months. The move will also reduce the profitability of this sector which was mostly unaccounted for. In fact we are already witnessing fall in the share prices of Real Estate companies. The spill over effect of Real estate will be evident in Cement, building materials and steel industry too but owing to government backed infra projects, this impact will be limited.
NBFCs will be impacted negatively with the demonetisation move. Housing loan demand will see a drop as consumers will wait for a price correction. Housing finance companies having a high exposure to Loan against property (LAP) and builder loans will be especially impacted. There may also be higher delinquencies in consumer loans and SME loans. With higher CASA, banks will surely reduce rates and there will be increased competition from banks. Though cost of funds will also reduce for NBFCs, the negative impact from a higher competition from banks will surely be material
A lot of black money was used into buying consumer durables like high end TVs and Air conditioners. The sales of consumer durables will see a sharp drop in the short term because of lower liquidity in the hands of consumers. Things are expected to normalise in a few quarters.
India has a thriving market for luxury goods which crossed $18 Billion mark in 2016. The demand for these goods has been increasing in double digits and was expected to register this growth until demonetisation came. Now, the actual effect of this step on luxury good market remains to be seen but it is safe to say that a lot of black money got re-routed to this segment in the past which is now eliminated.
Jewellery sector is known for its cash transactions which have been debarred now. This sector is largely unorganised and fragmented. Gold and gems were the top choices for people with black money. The big showrooms may still be able to contain losses because a large part of their business takes place through cards and banks but it will be smaller players who would be hit badly through demonetisation.
Tourism and hospitality
For the time being, one can expect tourism to take a blow. The domestic tourist does not have enough liquidity and we are referring to those who do not blow money on holidays and pay through cash. International tourists coming to India for more rustic experience will definitely keep away because the far nooks and corners of India are quite untouched by technology. Simple transportation, buying food and making bookings may be an impossible task at many destinations. The present condition in the country is also not very conducive. This in turn will impact the business of hotels and tour operators adversely for some time.
Indian telecom industry is humongous and boasts of being the 2nd largest in the world. According to TRAI, since 2007 the telephone subscriber base in India has grown at the rate of 19.5 % CAGR! The only effect of demonetisation that seems to impact telecom sector would be slowdown in demand for phones especially smart phones. Telecom is an organised and highly regulated sector and would not feel the pinch of this move and even if it does, it will be miniscule and indirect.
Auto and Auto Components
2 wheeler sales will be highly impacted as a large percentage of rural 2W transactions are in cash. There will be a short-term impact on passenger vehicles due to purchase deferment. Demand is expected to revive in medium-term.Luxury cars & SUV will witness significant impact due to wealth deterioration and decline in rural transactions that are mainly cash based.Over 70% of fist hand commercial vehicles are financed through banks but the secondhand truck sales have a higher percentage of cash and thus will be impacted. Demand for tractors will be materially impacted
Auto component sector will be impacted in the short term because of the decline in sales. However, a lot of players in the unorganised segment will be wiped out in the replacement market. This should give the sector a boost in the medium term.
Again a largely organised sector, Pharma is expected to do well in face of demonetisation which also happens to be the 3rd largest in the world in terms of volume and is expected to grow by 15% until 2020 overtaking US. In fact counterfeit drug industry that heavily relies on liquid cash is expected to be eliminated in wake of recent developments. Since drug manufacturing requires R&D and licensing this move shall thwart the illegal unorganised sector within pharmaceutical segment and result in benefit for the established and reputed players.
The slowdown in demand from the end user industries like Auto, Consumer durables and Construction will lead to lower demand and thus decline in volumes. Over leveraged companies will be especially impacted
Real estate is a major contributor to ad revenues of print media and thus a slowdown in this sector will definitely impact the ad revenues. Most multi system operators have cash dealings with local cable operators and their working capital will cycles will get elongated. Thus, Media sector will be negatively impacted in the short to medium term
Liquor sector will be slightly impacted especially in the hinterlands where cash dealings are more. However, the sector will largely remain unaffected
Oil and Gas sector will not be much impacted. The initial pickup in demand due to the petrol pumps allowing old notes to be used will boost sales. In the medium term, there may be slowdown in demand. Refining business will be unscathed. CNG demand will not be impacted much. Overall, the impact of demonetisation will be neutral on the sector.
With over 70% trucks off the road, the logistics sector is negatively impacted. Bu the impact will be short lived. Demonetisation will lead to rapid digitisation of currency and will give fillip to the e-commerce sector. This will definitely give boost to the logistics sector.
Power generation sector will have no impact due to demonetisation. The power distribution companies will also come out unscathed. The Discoms may see some delay in payments especially in areas where the payments were made in cash. The massive liquidity in the banking system will lead to reduction in interest rates and this will especially help the leveraged players in the industry. Overall impact is positive in the medium term.
This sector will be severely impacted. Large part of transactions done in cash in segments like paints tiles etc and hence will be severely impacted. As the underlying real estate demand ( 60-65% of consumption) will be severely impacted due to curtailment of black money, the demand for building materials will contract .
Demonetization has impacted the retail industry due to a liquidity crunch. As the Indian retail industry generates a lot of cash transactions, a reduction in sales will continue in the short-term, i.e. one-two quarters. This impact is being felt largely by small traders and the unorganised retailing segment as compared to the organised retailing and malls. Reduction in real estate will give impetus in the medium term.
Short term disruptions are expected to continue in Small and medium enterprises sector (SMEs), agriculture, professional service and consultancy set ups. For Chartered Accountants, post-demonetisation is going to be definitely busy and revenue generating period as the clients are sure to rush to find safe avenues for their cash. On the other hand, really small business owners like the grocery shop by the street corner are expected to suffer a lot. They will have to introduce all their earnings to banking system which will also rope them in and under other establishment laws and indirect taxation.
Most of the downs are expected to ratios and the calm after storm settles. It is expected that demonetisation is one of the many steps and long process that government is planning to take. In the wake of demonetisation, RBI is holding an important meeting on 7th December when the situation will truly unfold.