Opinion on DEMONETISATION

1. Is the action of banning Rs 500 and Rs1000 note good for Economy ?

A. Anything that can bring down the inflation and is helpful in employment creation is very good for the economy. As is likely, the mainstream banking system is likely to have surplus liquidity after next 50 days. 

This is likely to have 3 effects:

a. The banks shall be able to lower down the cost of lending, and accordingly the cost of deposits. This shall translate into lower cost of capital in the economy.

b. The NPA problem will look less of a Demon, once the banking system will have more money in the system. The NPA to Deposits ratio shall look dramatically benign. 

c. The NPA categorised borrowers will find it relatively affordable to service the outstanding loans with lower interest rates. This however is bit tricky as lots of corporates may suffer from choking of black economy. Its noteworthy here that 70% of NPAs are from Steel and Power sector. Increase in Capital Expenditure by Government can help them see through.

2. Will it not be easy for people to generate black money in the future, since there is a bigger denomination note of Rs 2000/-

A. We need to understand the difference between Black Money Generation Vs Black Money Handling ! Without a doubt, a bigger denomination note can help in convenient handling of large amount of cash. But, it cannot be the reason for generation of black money. People generally generate black money for two reasons:

a. To avoid taxes of all sorts

b. Because they are caught in the Black Money spiral. For example, lots of people had to convert their White money into Black money in order to buy Real Estate at the peak of Real Estate bubble during 2010-12. Similarly, the wholesalers in Old Delhi don’t receive any white money for their sale, as the entire value chain is built around tax evasion. Even if one trader would like to be honest, he may not survive the extra burden of taxes, as the margins are thin.

Once the undisclosed cash is sucked due to Demonetization, it will give golden opportunity for the entire business value chain to start afresh and start clean. The onus of compliance should lie upon us. Remember that whenever you pay in cash and without asking for bill, you are contributing to Black economy. Also, by doing this, your Tax Paid white money becomes black. Therefore, as consumers, we should always insist on Pucca Bills and pay by Card, Cheques or Mobile Wallets, wherever possible. This shall dis-incentivise the generation of future black money. The current phase is like rebooting the economy. After Dec 31st, 2016, all people will have only white money. Initially, there will be little incentive to convert into black. 

3. How is demonetization of 2016 any different than 1978, which was not a great success ?

Firstly, the Morarji Desai government had put a ban on currency notes of Rs 1000, Rs 5000 and Rs 10000/-. In those days, these were extremely demoninations and such notes were available with super rich people only. The circulation of such notes was mere 2% of the total currency under circulation. Whereas, in 2016, the banned currency notes represent 84% of the total currency under circulation. 

Secondly, in the current age of technology, with tracking possible for PAN Number and Adhaar Card number, it is nearly impossible to evade the eyes of Income Tax, RBI, SEBI and other regulatory body. Also, there are many ways of handling money which reduces the need for cash such as Credit and Debit Cards, Travellers Cheques and Mobile Wallets.

Thirdly, the target of demonetization in 1978 was Black money. However, in 2016, the target includes Black Money, Terrorism Funding and Fake Currency prevailing in the country.

In 1978, 30% of the banned currency never reached the banking system. in 2016, we will have to wait for that figure.

4. Will the demonetisation hit the GDP hard in the short term to medium term?

A. We see people in long queues outside banks. On the other hand, we see wholesale markets been closed for almost a week now. In all the malls and megastores, the footfall has dropped substantially. Today's HT reported that the occupancy in private hospitals has also fallen to half in Gurgaon. There are actually two factors affecting the current economic activity :

a. Shortage of Currency, affecting consumption across all sectors of the economy.

b. Fear of Income Tax Raids and finding escape routes. 

Shortage of Currency : The current shortage is likely to be over by 31st December, 2016 (subject to any miscalculation by RBI / GOI). Also, once the excess / unaccounted currency has been deposited into the bank, it will see a multiplier of around 6X (a kind of norm for Indian banking system). This is against a very low multiplier (2X-3X) of black money. Even if only 70% of the currency reaches the banking system (as it happened in 1978), there will be more liquidity in the economy.

Fear of Income Tax raids : I have no view about it !

5. How the demonetisation will affect the investments ?

A. Lets broadly classify investments into two categories :

Physical Assets : Real Estate, Gold & Silver 

Financial Assets: Equities, and Debt Instruments like Bonds, Debentures, FDs, PPF, etc.

Real Estate: This sector is the biggest destination for black money. Ever since the current NDA government was enthroned in power, black money generation had started to reduce. The effect of the same was visible in Real Estate slowdown and price correction. The problems were compounded with Real Estate Regulation Act (RERA) which aims at regulating the conduct of builders and buyers in the real estate sector. However, I think, this sector was not yet ready to receive the blow of Black Money ban. On 10th of November 2016, i.e. 2 days after the announcement of Demonetization, the newspapers quoted crash in prices of agriculture land and farm houses by 30% to 40%. The DLF share price has already corrected by 27% over last 5 days since 8th November. The recent move is likely to seriously affect the speculators of Real Estate. Going forward, I see little or no pain in affordable housing. There is likely to be moderate correction in ready to move medium price housing …a segment that is normally purchased with home loans. However, there is a bigger threat to price of land holdings in urban, semi urban and rural segment. Most of such deals take place with substantial portion of cash money. As it looks, the pain in real estate can last longer than one anticipated. One can hope that with price drops, rise in economy and decline in interest rates, the real estate sector gathers some steam in next 3-4 years. Till then, there is enough unsold inventory with the builders. Another thing to watch out is further delay in projects under construction. The cash strapped builders will not know where to look for more funds. Under the scenario, the rentals in the ready to move property may rise over next 2-3 years. I will not be surprised to see 2003 types valuations, wherein the rent payable for an apartment in Noida was equivalent to EMI after 20% down payment. 

Gold: Gold and Silver are imported commodities and their prices are determined by global demand and currency movements. Gold and Silver have been the next big destination for conversion of black money after Real Estate. With missing black money, India’s demand for gold may show signs of decline for next 1-2 years. The international prices may not get hugely affected by decline in Indian demand. On the other hand, any global financial risk may increase the price of gold in dollar and rupee term.

Equities : More white money in the banking system leads to lower interest rates and easy borrowing. This shall eventually lead to higher meaningful consumption, increased Capex and more employment. Fall in real estate prices should result in lower cost of production, as commercial Real Estate is a factor of production. Overall, Equities will be the biggest beneficiary of the black money ban. However, it is noteworthy that equity markets may remain volatile till the liquidity is stabilised i.e. 3-4 months. Also, one should stay away from penny stocks as they had been heavily used for conversion of black money by some small business promoters. SEBI / RBI / Income Tax may lodge investigation in such scrips.

Debt Instruments : Interest rates are likely to go down with fall in inflation and eventual surplus liquidity in the banking system. This is beneficial for long duration government bonds. Also, it will be positive for Debentures of private companies which are rated between AAA to A. Anything below that can prove to be risky as their can be compliance issues and some dependence on cash economy. 

Next 6 months are likely to remain uncertain in many ways. Beyond demonetization, there will be factors like Donald Trumps economic policies and FED Interest Rate Hike. 

We should be watchful, and not fearful, as everyone else is already fearful. 

Thanks and Regards

Sameer Rastogi