Demonetization &

Impact

ByDeepak Bhadouriya

“Modi's Demonetization Is

a Cure Worse Than The Disease For India”

-Forbes

Demonetization around the world

Demonetization has been braced in the past by many

countries. They include:

Cont…

Country Year demonetizationPhilippines  2015 Old currency

Zimbabwe 2010,2015 1 hundred trillion dollar

USA 1969 $1000 and $10000

European Union 2002 Old currency

Australia 1996 polymer bank notes

Soviet Union-in 1991 North Korea-In 2010 Zaire-In 1993 Myanmar-In 1987, Ghana-In 1982 Nigeria-In 1984

Demonetization-Failed

Similar kind of demonetization has been done in past. In India it has done :

1 12 January 1946, wherein banknotes of INR 1000 and INR 10000 were withdrawn.

2 16 January 1978 wherein banknotes of INR 1000, INR 5000 and INR 10000 were demonetized.

In 2012 CBDT had recommended against demonetization, considering demonetization not to be a solution of curbing black money, which is largely held in the form of benami properties, bullion and jewellary.

Difference w.r.t. to 2016 demonetization with that of previous once obviously is size.

Previous ones barely has impacted common people but this one is huge with 87% of currency was out of the system.

Indian Scenario

November,8,2016 a day when Indian govt. launched a surgical strike against a

black money in the economy. The Hon'ble PM of India, in an unscheduled live TV address to the nation on

November 8th of 2016 at 20:15 declared circulation of all INR 500 and INR 1000 bank notes as invalid with immediate effect.

Issuance of new INR 500and INR 2000 notes in exchange of old banknotes was announced.

With the exchange of new denomination notes of INR 2000 and not INR 1000, the conversion of black money would be curbed.

Demonetization has been done in effort to: Stop counterfeiting of the current banknotes allegedly used to terror

funding. Crack down of black money in the country.

Introduction

High denomination notes are known to facilitate generation/circulation of black money.

In value terms, `500 and `1,000 banknotes together accounted for 86.4 per cent of the total value of banknotes in circulation.

Total no. of banknotes in circulation rose by 40% between 2011 and 2016. Increase in no of notes of INR 500 denomination was 76% and for INR 1000

denomination was 109%. Infusion of new series bank note is being regulated by RBI. The world bank in july,2010 estimated the size of shadow economy for India

at 20.7% of GDP in 1999 and rising to 23.2% of GDP in 2007. A parallel shadow economy corrodes and eats into the vitals of the country’s

economy resulting in: -Inflation adversely effects the poor and middle class. -Depriving the Govt. of its legitimate revenues. -forged cash used to fund terrorist activities against India.

Purpose/Need of Demonetization

Accordingly, steps have been taken to demonetize the high denomination notes and help to: Curb financing of terrorism through the proceeds of fake Indian currency

notes(FICN) Curb the use of FICN funds for subversive activities such as espionage,

smuggling of arms, drugs and other contrabands into India. For eliminating black money which casts a long shadow of parallel economy

on our real economy. To lower the cash circulation in the country which is directly related to

corruption in our country.

Cont..

In order to implement the above decision of the govt. and keeping in view the need to minimize inconvenience to the public, several Operational Guidelines has been issued:1) Old high denomination bank notes may be deposited up till Dec. 31, 2016.2) Old high denomination bank notes can be exchanged as per the limit fixed by

RBI.3) No limit on the quantity or value of Old high demonetization bank notes to be

credited to the account of the tenderer maintained with the bank on complying with extant KYC norms and valid proof of identity.

4) Old high demonetization bank notes tendered can be credited to third party account on submission of specific authorization along with proof of identity.

5) Limit in cash withdrawn and ATM withdrawn.6) No restriction on the use of any non-cash method of operating the account

which includes cheques , DD, credits/debits, mobile wallets, electronic fund transfer mechanisms.

Operational Guidelines

Old high denomination bank notes(Rs.500) would continue to be accepted at

certain places for public utility such as Government Hospitals and pharmacies in these hospitals/railway ticketing counters etc. up to a specified amount for a specified period.

Special provision for farmers and traders for buying agricultural produce has been introduced from time-to-time with respect to withdrawals and use of old high denomination notes.

Special provisions for weddings with respect to withdrawal of cash has been introduced in order to minimize the inconvenience to the public at large.

Relaxations

Special provision for receipt of advance salary by central government

employees up to level of Group C and equivalent level in defense Para Military Forces, Railways and Central Public Sector Enterprises.

Expansion of Banking Correspondents Network for rural areas.

Options for withdrawal of new currency from debit cards has been allowed from petrol pumps and big bazaar.

Increase in use of digital wallets.

Cont..

Because India’s economy relies predominantly on cash, the effects will be far greater. ATMs are scarce, and few rural Indians have a credit or debit

card.

Demonetization of high denomination notes would have leap in long term benefits which could be classified as direct and indirect impact in the economy.

Direct Impact:1) Fake currency- out of circulation in one stroke.2) Hawala sources dried up- Funding stops to terrorists, Naxalites and

underworld.3) Real estate prices dip to be seen in the long run.4) Reduction in inflation.5) Reduction in Fiscal Deficit.6) Reduction in lending rates7) Increase in GDP

Major Benefits

Indirect impact:1) Kashmir moved to normalcy- Blow of insurgency, no more schools being

burnt and no stone patters found.2) Use of Apps and cards- initial steps towards digitization in india with the

involvement of small vendors lending to transparency in the system.3) Gold stock- Declaration in the stock maintained by the jewelers on a day-to-

day basis, which if continued would have control over generation of worth from black money.

4) Increase in revenue collection by the government authorities.5) Simplification in tax policies and reduction in tax rates in the upcoming years.

Major benefits

Scarcity of cash due to demonetization. Sporadic violence wherein people attacked bank premises and ATMs with no major

injuries Large chunk of the population, especially at the bottom of the pyramid and rural

population highly impacted due to poor banking facilities and extremely higher dependence on hard currency.

Various tribal areas living in isolation and illiteracy have been impacted adversely in the short run.

Certain sectors necessitating frequent use of cash on a daily basis including hospitals, households, roadside vendors, domestic workers, cab drivers, doctors, transporters likely to face interim disruptions.

Farmers may face financial difficulties to pay daily wages to laborers in smaller denominations and manage other farming expenses.

Slowdown in consumer spending due to limited availability of cash.

Impact analysis: Short Term

This essentially represents a change in regime for the real and financial

economy.

Internationally, the government is likely to get thumbs up for the move and more countries could potentially see this as a viable option to curb black money and stem illegal financial activity. Last, though this move by the government may not be a first, having being tried by earlier governments as a tool to fight corruption.

Impact analysis: Long Term

Long Term

Impact analysis: Long Term

Till 20th of December, the Indian markets have fallen a bit more than other

emerging markets in Asia. The S&P BSE Sensex is down 3.8%, which is more than more or less all other Asian emerging markets.

The extra fall in the Indian markets compared to others could be due to many factors, including high valuations, but it’s very likely that the demonetization effect is mainly responsible for the fall.

BSE’s mid-cap and small-cap indices have fallen by over 6% each at the time of writing. And in truth, the largest impact of the government’s move will be in the unorganized sector, which isn’t represented in the market.

Asian and Indian Stock Market Comparison

Effect on stock market

POSITIVE IMPACT NEGATIVE IMPACT

E-commerce and Fintech Agriculture

Payment and Gateways Luxury goods

Mobile wallets Real estate

Online retail Commodities

Net and payment banks Traditional Retail

E-marketplace

The Sectorial Impact

By the second week after demonetization, sale of cigarette witnessed a fall of

30-40 percent. E-commerce companies saw up to a 30 percent decline in cash on delivery

orders. E-payments options like PayTM and PayUMoney saw a rise. Real Estate- Primary transactions may be impacted, secondary sales may to

some extent.

Business

Demonetization could directly benefit the FISCAL situation in country. The

unaccounted money is a direct benefit to RBI and some could be used by Govt. to reduce fiscal deficit or use it for several other development initiatives.

The move towards a cashless economy will boost savings in financial assets. Demonetization has lead to inflow of cash in bank accounts. Increase in money supply and reduction in fiscal deficit would lead to

reduction in interest rate. Spike in the usage of debit card and credit card post demonetization was also

reported. Tremendous long term benefits as most of the legit money in cash will go

back in banking system.

Banking

Asset finance companies may see short to medium term pain

as a large chunk of business is cash based.

Housing finance companies to see key impact on loan against property.

There may be a slowdown as people may stop buying the second or third house, which may affect developers. Small-finance banks will be big beneficiaries on the deposit front.

NBFCs

There's no material impact as average transaction size is very small. However,

slowdown in smartphone sales could potentially slower adoption of mobile broadband subscriber penetration.

  

Paint companies which are into big project sales, deal in cash component worth 30-40% of sales, while for shops which have higher retail sales, cash component could be 70-80%.Therefore, paint companies could face fall in sales in the short term.

Telecom

Paints

  Companies and dealers are indicating that volumes may get impacted in the

near-term as real estate demand decreases(which is 55-60% of overall demand), especially in tier 2 and 3 cities, may get affected in the interim.

Demand in tier-1 cities has been weak for the past 2-3 years. But infrastructure demand, backed by government spending which has been driving growth, is unlikely to be impacted.

The impact won't be big largely due to the B2B nature of business. However, payment to sub-vendors may face some liquidity issues.

Cement

Capital Goods

Adverse impact on input-output channels in agricultural sector. Sale, transport, marketing and distribution of ready produce to wholesale

centers or mandis, adversely impacted. Distributions, breaks in supply chains feedback to farmers as sales fall. Increased wastage of perishables. Lower revenues that show up as trade dues instead of cash in hand. According to NITI AAYOG it had only a limited adverse effect on the

farmers. Rabi output in 2016-17 could be 4.96% higher than 2015-16 while kharif

production may be 3.5% more than last year.

Agriculture

The recent demonetization has given a huge blow to real-estate sector, where almost one-third of transactions still involve unaccounted money.

Nifty Realty Index closed at 175.2, down 11.60% on the 9th of november. This will bring down property prices. Will lead to correction of real-estate prices in market where investment

was done through black money. Real-estate sector in India constitutes almost 11 per cent of the GDP, and

accounts for more than 50 per cent of the current black money market. Freeing of this money will give a rise in GDP.

Demonetization will flood the Banking system with funds driving down both interest rates on Deposits and Loans.

Historically at Low interest rates Real Estate industry gets a massive boost as property becomes attractive to everyone: Buyers, Investors and even that invisible category called Businessmen/Professionals.

In 2009, when mortgage rates were about 8.25% and housing sales rose 18%.

Real-estate

Demand is likely to dip for a couple of months for two-wheelers, but

passenger vehicles and tractors will be less impacted. In the two-wheeler industry, around 35-45% purchases are made via financing, while the rest are though banked cash, or are simply "unaccounted".

But in the passenger vehicles segment, close to 75%-80% of sales are either through financing, or even down payments are made mostly by cheques -so this segment could face less heat.

As for tractors, close to 65% of the purchases are financed, therefore the impact of cash squeeze could be minimal

Auto

The move is good for the organized industry. But in the short term, it may

impact the working capital in FMCG distribution. Anecdotally, there's always a huge panic among distributors -business may be impacted in the short term with liquidity choking up, thereby impacting FMCG revenue growth.

There will be a shift from unorganized to organized sector in the jewelry industry. Over the medium-term the organized industry players will benefit at the cost of the unorganized players

Gold imports through the unofficial channels are likely to reduce.

Consumer Staples/ Jewelry

Demonetization is not expected to have any major impact on the Indian

pharma market and demand is not expected to get impacted in a big way. But it has negative impact in short run as sale likely fell 8% in November. However, luxury hospitals may see some impact due to spending cuts.

Since Private Educational Institutions take huge amounts of donations in Cash which is 40 % to 50%, we expect that this move will impact the Private Education Institutions receipts.

Pharma

Education

A possible fall in the interest rate will be positive for yield players.

Coal prices have risen recently, with China cutting domestic production .With Trump focusing on US competitiveness, there's a good chance that China will reciprocate allowing coal prices to fall again.

Demonetization should only have a marginal impact on Indian oil and gas sector. According to deutshe bank, it sees a marginally adverse medium-term impact on sales of petroleum products. It reiterated its preference for refiners(HPCL, BPCL & IOC) in the oil sector and petronet CNG among the gas utilities.

Power and Coal

Oil and Gas

Demonetisation has shed its gloomy shadow on the booming tourism and hospitality

industry.  India’s hospitality industry has been severely affected as the hotels have lost a large

number of pay-in-cash-only clientele due to demonetization. Around 60 percent drop in hotel bookings have been reported. Peak tourism period of November-December badly hit. For tourist destinations beyond metros, business may be down by as much as 40%. Tourism business in metros may go down by 10%. Cash shortage at airports and hotels are a big problem. And many national monuments

entry points don’t have card payments facilities. Western countries have issued advisories on cash crunch in India. 

TOURISM 

Real estate slowdown has hit steel, and may hit further. Aluminium, copper,

zinc also hit since they are raw materials in building industry products. If auto sales are hit badly, metals business will do worse. 

Read more at:http://economictimes.indiatimes.com/articleshow/55843771.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

METALS

Demonetization is expected to have mixed effect on textiles. India’s textile export volume is good, all the export would not be affected but

domestic textile market will be affected. The overall impact on the sector, however, is expected to be limited as one

third of the Indian textile industry is estimated to be export focused(according to ICRA)

Textile

Demonization has very less or almost negligible effect on IT industry. If the company handling domestic and international projects there is little

effect, for domestic projects payment will delayed. The delay in payment gradually effect monthly income, working capital and salary to staff.

Information technology (IT)

Demonization has an negative impact on logistic industry The transporter business, one of the unorganized sectors is largely cash based. Logistics companies have faced an upto 20% decline in volumes from their e-

commerce business.

Logistics

India is amongst the most cash-intensive economies in the world and with such a

high degree of reliance on cash, the impact of demonetization on FMCG industry can be much larger than envisaged by management pundits and think tanks.

It impacted both the Retail Transactions between Consumers to Retailer and the ones between Retailers to Distributor.

 For many large FMCG companies in India general trade contributes to ~ 90% of total sale and is catered through millions of outlets spread across India

Further FMCG sale is also dependent on the rural economy which contributes to 35-50% of total sales. Majority of this sale is heavily dependent on cash and the liquidity crunch will see some impact in sales growth for FMCG players

In FMCG Industry, more than 80-85% transactions between retailers to distributors are cash based.

FMCG

INFRASTRUCTURE

It has negative impact for now but positive in long term. Power demand and road traffic have been hit. Road companies faced short-term cash flow problems because they weren’t

able to collect tolls, but things are limping back to normalcy.  Wage payment to labour can be an issue for some time, which can impact

execution in the short term

There has been a significant impact on inbound travel. Some airlines have

seen bookings go down by about 16% in the week after demonetization compared to the one before that.

Poor sales have forced all airlines to bring forward their airfare sales—usually reserved for the low season

Business jet operators say several charter flights have been cancelled as payments are often made in cash.

Aviation 

This has been a booming industry that works largely on cash. In the past few

years, beauty parlours have mushroomed on almost every street of urban and semi-urban India. Although a few of the larger, organized parlours do accept credit and debit card payments, most parlours transact mainly in cash because it is often seen as a luxury spending fuelled by unaccounted income.

Beauty parlours

What GST essentially does is it merge a no. of existing indirect taxes into a

single tax. Revenues of state govt. and local bodies would substantially reduce as they

would not able to levy VAT, luxury tax etc. instead they will get SGST which will be lower than previous revenue.

So, after GST implementation the govt. is expected to face a shortage of revenue(short term effect) & would want a larger tax base.

So, demonetization is likely to result in a larger tax base by bringing the money stashed back into circulation & through the push towards digital transaction . It is in the economy’s interest to keep most of its money in banking system.

So, it is necessary step as it will help in an easier implementation of GST.

Impact on GST

https://

rbidocs.rbi.org.in/rdocs/AnnualReport/PDFs/0RBIAR2016CD93589EC2C4467793892C79FD05555D.PDF

http://www.livemint.com/Politics/a0Fk7NwHWsKcxiu4A3i4tK/How-demonetisation-has-impacted-key-sectors.html

http://www.forbes.com/forbes/welcome/?toURL=http://www.forbes.com/sites/greatspeculations/2016/12/02/modis-demonetization-is-a-cure-worse-than-the-disease-for-india/&refURL=&referrer=#1d41995d5c58

References

Thank you