Demonetization: On Economy in wane with the common man in lane

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The era of black colour is again finally fading and the hope of white colour will resurface and spread the shine everywhere. Black money then and now. It first happened in 1946 when the Reserve Bank of India demonetized and then circulated Rs 1,000 and Rs 10,000 notes. These Currency Notes were again last scrapped by the Moraraji Desai government in 1978 after Independence. The demonetization move of 1978 too was made to tackle the black money economy. The move was executed under The High Denomination Bank Notes (Demonetization) Act, 1978.

Demonetization is the act of stripping a currency unit of its status as legal tender. Demonetization is necessary whenever there is a change of national currency. The old unit of currency must be retired and replaced with a new currency unit. The national currency of a nation is usually the predominant currency used for most financial transactions in that country. Black money stashed as high value currency is much less than black money as untaxed income. That is used for investment in real estate, commodities, stocks, benami lending to secure political or administrative goodwill and fame.

The motto behind this directed towards freezing the secret funds of politicians, businessmen, un-organized builders lobby, terror financing. Let's analyze the sectors that will be most affected by de-monetization because of the high level of cash spending habits. As Indians struggle to come to grip with the second de-monetization of currency since Independence, the scale and scope of this action is significantly bigger.

Real Estate will be one of the most affected sectors. Everyone believes the same and hence the Nifty Realty Index closed at 175.2, down 11.60% on 9th Nov 2016. Costs of real estate dive down when the buying activity goes down. Real estate does not have an index value, unlike gold or stocks. There is no chart where you can look up the prices and transact accordingly. It is completely driven by the demand and perceived value.Unorganised builders will be most affected and the sector will drag down cement and ceramic sectors also along with it.

Gold prices: As investors rushed to invest in safe havens, Gold Futures touched a high of Rs31, 376 and was trading at Rs30, 500 up 2% on 9th Nov 2016.

Banks should benefit from high deposits and transaction volumes, lower cash handling costs and greater acceptance of digital channels. There are likely to be secondary benefits for the insurance, asset/wealth management companies through higher financial savings.

Tourism: Indian Local Tourism will also get affected as they lose large chunks of the pay-in-cashonly clientele. Illegal foreign currency conversion is also reported to be badly hit, because they
were big acceptors of Rs500 and Rs1000 denominations of currency.

Even the favorite foreign destinations like Thailand, Malaysia, Nepal, Singapore, Europe, Maldives, Hawaii, Vietnam, Sri Lanka, Indonesia and many more.

Agriculture: Farmers are those which seem to be hampered most, as they are very less digitalized. Kharif crop is ready for this season and the time has come for Rabi planting. Their planning for Rabi has collapsed because of cash crunch as they are not able to buy the fertilizers for it. Cash is not easily available with them ,but without losing hope that there would be little relief to buy seeds, repay small loans since the central bank has provided additional 60 days for repayment of housing, crop, farm and microfinance loans worth up to 1 Crore.

The impact of demonetization on Chinese economy is visible, as there export market is drastically declined; because of crunch of funds with Indian traders and merchants. As India is a huge buyer
for China. India imports most of its crude oil from OPEC nations, in a bid to promote trade and build relations with major Middle Eastern partners, such as Iran, Kuwait, Nigeria, United Arab
Emirates and Saudi Arabia, oil import bill is likely to reduce.

Luxury items will have a drastic negative impact. Majority of the people spend their undeclared income on such products. All luxury segments like clothing, electronics, luxury car, furnishing and
allied business will take a hit. Media and hospitality industries are also likely to get affected.

Sectors that we feel will not be affected are– Pharma, FMCG, Education, Hospitals, Energy and Telecommunication

It is a great step, which can have long-lasting impact on the economy as well as the equity market.

Discussion:

  1. Is Demonetization large shock for the Indian Economy?
  2. Do you find a recovery of the economy with a projected GDP of 11%in the next 2 years, when traders and businesses find a tough time to go with the less cash transactions.
  3. The Impact is when the currency is put back in the form of new currency. The impact depends on whether you are replacing the entire amount that is being surrendered by the public, or only a part.
  4. What the government chooses to do on the Goods and Services Tax. Already given the players who have been really affected by this decision are the traders. Now if you want them to reorient their systems and get ready for GST rollout. How it's going to work?

References:
Economic Times: By Narendra Nathan ET Bureau Nov 14, 2016
Mint: Consequences of the demonetization shock Nov 18, 2016
businessworld.in/tags/demonetization-65149

Created By:
Dr. Amit K. Sinha (Associate Director)
Pallavi Deshpande (Research Associate)