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Demonetisation: Spending squeeze to hit India's GDP growth for 2 quarters


21 Jun 2013
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Days after Prime Minister Narendra Modi announced in a rare late-evening address to the nation on Tuesday that Rs 500 and Rs 1,000 notes would cease to be legal tender within a couple of hours from the announcement, Indians are struggling to come to terms with the new currency regime. But it’s not just the common man of India; the Indian economy is also set to take a hit in the immediate term because of a sudden squeeze in overall spending, a brokerage and trading advisory firm has said in its presentation on the challenges and effects of demonetisation.

The immediate impact of the demonetisation move has been visible across the country, with people queuing up at bank branches for long hours to exchange their Rs 500 and Rs 1,000 currency notes, and in serpentine queues at the few automated teller machines (ATMs) dispensing cash in the Rs 50 and Rs 100 denominations.

Some bank branches have since Thursday started allowing withdrawals and exchanges in the newly designed Rs 2,000 notes, but ATMs are not yet equipped to dispense these notes. Finance Minister Arun Jaitley on Saturday informed the nation that ATMs would have to be recalibrated for new currency notes, and that would take two or three weeks.

While the demonetisation move – certainly a bold move to cleanse the economy of black money – would be in the larger interest of the country in the medium to long term, its immediate impact on both the people and the economy of the country are negative. According to a presentation by Anand Rathi Securities, India’s gross domestic product “(GDP) will decline in the next two quarters due to reduction in overall spending”.

Business Standard lists the key takeaways from the presentation:

Immediate impact: All-round negative

In the short term, the demonetisation exercise is a logistical nightmare – managing the cash replacement at banks and smooth functioning of the banking system is a challenge, and that leads to a slowdown in consumer spending, given a limited availability of cash. This also means severe liquidity issues for cash-based sectors like real estate and jewellery. Over the next two quarters, GDP might decline amid reduced overall spending.

Next 4-5 months: Silver lining

Those with legitimate income would over the next four to five months deposit their money in banks and, apart from the initial hassles associated with the banking system, they would have nothing to worry about. However, those with unaccounted money would face several problems.

To begin with, those who choose to do nothing with their money stash will be left with banknotes that are rendered worthless. “Every banknote is a liability of the government and RBI (the Reserve Bank of India),” says Anand Rathi Securities, “so notes becoming worthless will benefit the government as the liability will be reduced.”

For those who declare their unaccounted money, 60-70 per cent of the money will go to the government in the form of taxes and penalties, the brokerage points out.

As for a third category – of those who would try to launder their money – there would be many severe risks, including penalties and prosecution. The money sought to be laundered, in any case, will enter into circulation and remain there.

“It is expected that even if 50% of the around Rs 14 lakh crore worth of notes are legitimate, the remaining Rs 7-lakh-crore unaccounted money will see 60-80% (about Rs 5 lakh crore) coming to the government in the form of extinguished RBI liability and taxes and penalties. This Rs 5 lakh crore is enough to take care of India’s entire fiscal deficit for one year or more,” according to the presentation.

Overall economic impact: Very bright
After a slow rate of GDP growth for around six months, the subsequent two years could see sharp “hockey stick” revival in growth. Inflation could fall sharply, with a reduction in real estate prices and transaction costs involved there.
Besides, the government’s deficit could see a huge windfall over the next two years. The rupee is expected to strengthen, with inflation dropping and economy getting a solid boost.

Overall, the banking system is estimated to get a boost, as around Rs 7-8 lakh crore base money (new legal money) would enter the system, further creating three to four times more money due to re-circulation. The real estate and jewellery sectors, though battered initially, would stabilise in the next six months, says Anand Rathi Securities.

Effect on various asset classes: Positive
Bonds: Prices will rise, as interest rates drop.
Real Estate: Expected to fall by 20-25 %, and stabilise thereafter.

Gold: The impact on the yellow metal is a little uncertain. It may be neutral or negative. “Lower black money will depress demand, but at the same time gold is a hedge against uncertainty, so those still wanting to park black money might prefer to put it into gold instead of cash.”

Equity: It could benefit the most, for three reasons. First, there will be a gradual shift from physical assets (real estate/gold) to financial assets. Second, the organised sector – companies, especially the listed ones – will benefit due to fewer cash transactions. And third, lower inflation and interest rates will benefit listed companies through lower borrowing costs, which will increase their profitability and valuations.

Asset allocation and re-balancing might now play an even more important role, making proper financial planning imperative.

As to whether the new Rs 2,000 notes will create more black money or not, the Anand Rathi Securities presentation says that is always a possibility. However, the present demonetisation exercise would have created a psychological impact by setting a precedent, sending out signals especially to large-scale evaders, who would now think twice before accumulating black money.

Demonetisation: Spending squeeze to hit India's GDP growth for 2 months | Business Standard News


31 Mar 2011
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Initially, it will be impacting, but later in long term, this will take India to newer heights.
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