Demonetisation- Its Challenges and Effects in Days to come

Sheela Mamidenna

The Government's sudden move to demonetise Rs.500 and Rs.1000 currency notes late on Tuesday took the whole country by storm. Reactions poured in from every corner. While many common people stood in line waiting for Rs.100 notes to run their homes, many were of the opinion that in the long term it was for the greater good. Financial firms, analysts, chartered accountants seem to be on the same page that this move will have a positive impact in the long run.

Though an accurate quantification of the transitory impact that demonetization could have on the GDP is difficult, as there are only guesstimates that the best financial analysts can come up with given the size of the cash economy( more than 50% agree) still prevalent in the country. Sure, almost everyone agrees the small enterprises and the unorganised sector that use cash on a regular basis for their transactions could be inconvenienced for a while, and that will have a negative impact on the economy. Similarly cash-dependent, consumption-led sectors will also feel the pinch, while investment demand will be tempered in the short-term.

However, most economists and analysts agree on one thing, that Tuesday's move could change the face of the country's economy, improve the government's fiscal position and tax compliance.

Let us take a look at the long and short of demonetization.

1. Immediate impact: expected to be negative

a. It will be a logistical nightmare to get cash flowing and that will hurt small businesses

b. Consumer spending will slow down due to limited cash availability

c.The real estate and jewellery sector will bear the brunt of the decision

d. Due to the slowdown, in the short term we can expect a negative impact on the GDP.

2. Mid-term:

Those having legitimate income will deposit their old currency in the banks and apart from the initial hassles associated with the banking system, they will have nothing to worry about. However, those having unaccounted money will face several problems as follows:

a. Those who declare their unaccounted money, approx 60- 70% of the money will go to the Govt in the form of taxes and penalties.

b. People who have not used the formal banking system till date will start using it, bringing a large amount of unaccounted for money into the formal system, improving the liquidity situation in the country.

c. With more liquidity, interest rates for both consumer and commercial borrowings will come down, giving a fillip to the economy.

3. Overall Economic Impact:

a. GDP growth is expected to be negative for around 6 months. However, subsequent 2 years will see sharp revival in growth.

b. Inflation rate is expected to fall.

c. Government will have more liquidity for social welfare schemes

d. Currency is expected to strengthen as inflation drops and economy gets a boost.

e. The realty sector will come to terms with the unavailability of ‘black money’ and real estate prices will slowly be in-line with real returns and rent income

4. Effect on various Asset classes:

a. Effect on Gold is a bit uncertain and may be neutral/ negative. Lower black money will depress demand, but at the same time, gold is a hedge against uncertainty and those still wanting to park black money may prefer to put it into gold instead of cash.

b. Unorganised real estate will suffer a slowdown, or even a disruption.

c. Equity is expected to benefit the most due to three reasons:

i. There will be a gradual shift from physical assets (real estate/ Gold) to financial assets.

ii. Two, the organised sector (corporates, especially listed ones) will benefit due to fewer cash transactions.

iii. Lastly, lower inflation and interest rates will benefit listed corporates through lower borrowing costs, thereby increasing their profitability and valuations.

And surely, as is obvious from the many text messages that you have received from banks and financial institutions, their stocks should soar, with a lot of cash that was beyond their purview suddenly coming into the formal system.

There may or may not be significant impact on corruption, but the formal economy is sure to get a boost in the long run.