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Demonetization-What is Clear

What is clear is as follows:

1. Banks will benefit, as much of this ₹ 15 lakh crore in currency will get deposited. Even if only 10 % remains with the banks it means an incremental ₹ 1.5 lakh crore of current and savings account ratio (CASA). Interest rates are headed lower system-wide as banks’ cost of funds decline, they lower rates and park these flows into government paper. Already we have seen Indian 10-year yields fall by 40 basis points in the last week, despite yields rising globally. Also remember this money left with the banks will have a multiplier compared to it sitting in cash. The system should be awash in liquidity.

2. The Reserve Bank of India (RBI) will cut rates sharply and quickly. This reduction in currency will be a deflationary shock, with certain asset markets declining sharply and economic activity weak for the next two quarters at least. Inflation will decline giving the RBI the space to cut.

3. Financialisation of savings will accelerate as both property and gold will now be challenged as alternate stores of value. The cost of capital will reset downwards for the country.

4. There will be a significant negative wealth effect. Some percentage of this ₹ 15 lakh crore will get wiped out. Black money that is either simply burned, or loses 30-40 per cent as the cost of conversion to legitimate money. Wealth destruction is also inevitable in property, as prices fall and markets freeze. There will be a shock to high end-discretionary consumption.

5. There is likely to be some behavioural change as those parts of the economy relying on cash need to adjust. Individuals and business that were using large chunks of cash on a daily basis will take months to rebuild these cash levels given the limits on daily withdrawals. In the interim, they will have to adopt e-payments or cheques to stay in business. As their business moves into the formal economy, it will be difficult to reverse and the tax buoyancy of economic growth will improve for the government.

6. For the vast majority of Indians, those having less than ₹ 2.5 lakh in cash or agriculturalists, things will normalise in a few weeks. They will simply need to wait till they can get the new notes. For these people, it is largely a logistical issue of note replacement.

7. Small and medium-sized enterprises (SMEs) will be in trouble. Many are doing business entirely in cash. Demonetisation, combined with goods and services tax (GST), will kill their business model, which was dependent on tax and labour arbitrage. Many sectors will see large market share gain for the organised players. Lenders to the unorganised sector will need to stress test their exposures; there may be far greater credit issues here than investors are modelling.

8. Expect more measures to tackle the flow (fresh creation) of black money. Demonetisation handles the stock problem. Once the short-term logistics around cash replacement are fixed, expect new restrictions on use of cash and continued curbs on cash withdrawals. These steps will continue to force behavioural change.

9. I am frankly quite amazed as to the extent of cash in the system and its all pervasiveness. It seems that there is no supply chain untouched, and even large organised players need to deal with cash. There are many segments of the economy which operate only on cash. Whether demonetisation works or not, we have to attack this cash and the mindset. That much is certain.

wrote Akash Prakash

2 replies on “Demonetization-What is Clear”

It is nice to know all the positives. Long live the banking system that is being killed periodically due to poor banking discipline and wrongful govt policies of the past.
What has not been stated in this write up is, the surplus liquidity will again find its way to fraudulent businesses and businesses setup/run by politicians and persons closed to them (politically exposed persons). Already I hear that a public sector bank is syndicating a 1000+ crore loan proposal for the restructured business group of an influential Maharashtra based central minister – a proposal with which the banks are not comfortable with. Leverage (debt equity ratio) to big industrial houses will increase, even if they are already big borrowers. Money was needed in the MSME sector, but that sector wont find takers in the banking sector, will be a double whammy effect on them, who are already facing monetary drought.
As much as 45% of Indian GDP comes from the informal sector that is largely dependent on cash. A very large amount of consumption, for buying vehicles, houses and gold and selling agricultural production has been through cash – everyone knows that India’s recent economic (and equity market) surge was due to India’s domestic consumption model, which will be severely hurt, and that will make the markets and the economy collapse.
Sudden USD strength due to US’s own decisions will put a bigger strain on the rupee, which has started its journey to be beyond Rs 70.
Those who werent a witness to the US Great Depression of 1929-33 may soon be able to see it as two similar rulers in their respective countries go about conducting irrational surgical strikes.

Aptly put by @AP. SME’s are the lifeline of Indian economy and we keep coming with policies to make their life difficult and keep helping the real looters big MNCs.

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