Alpha Ideas

In pre-election speeches in Goa and Karnataka, Modi said that demonetisation was not the last bow in his quiver. “I have more projects in mind to make India corruption-free. …We will take action against ‘benami’ property. This is major step to eradicate corruption and black money”

With the passing of the Benami Transactions (Prohibition) Amendment Act, 2016, Modi now has the statutory powers to go after property crooks, most of whom are either politicians or realtors connected to politicians. The law is draconian and  it can be used to confiscate benami properties. Demonetised money can be laundered sometimes, but confiscated property is gone forever.

Under the law, once the government sets the process in motion, an initiating officer will serve a notice on the benamidaar and take the property under his control. An adjudicating officer will then examine all documents and evidence and pass an order on whether to confiscate the property. Once the property is confiscated, it will be managed by an administrator till a further course of action is prescribed against the offender. What will further strike fear in the minds of beneficial owners and benamidaars is the provision of a jail term and massive fine if found guilty. The amended Act provides for prison terms of up to seven years and fines of up to 25 per cent of the fair market value of the confiscated property.

If the law is used to go after many high-profile benamidaars, the property market will crash. That will bring its own deflationary trends and possibly lead to a systemic crisis, for the real estate industry has deep linkages with the real economy, the asset markets and the financial system.-wrote Jaggi

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