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Currency Demonetization

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Currency Demonetization research & ranking 2016

Event update: In an unprecedented move, the Indian government announced that the existing currency notes of Rs.500 and Rs. 1,000 denominations will cease to be a legal tender from 8th November mid-night. The RBI will issue new notes of Rs. 2,000 and Rs.500 denominations, which will be placed in circulation from 10th November 2016.

Regulation Details of Currency Demonetization

  • Currency notes of Rs500 and Rs1,000 denomination would not be a legal tender from November 8, 2016 midnight.
  • The public will have 50 days between November 10, 2016 and December 30, 2016 to deposit old notes of Rs.500 and Rs1,000 after showing a proof of identity. Besides depositing money in bank accounts, the Rs500 and Rs1,000 notes can also be exchanged with lower denomination currency notes at designated banks and post offices.
  • The exchange of old notes, however, will be limited to Rs2,000 between November10 and November 24 and it will be increased up to Rs4,000 between November 25 and December 30.
  • Those unable to deposit Rs500 and Rs1,000 notes by December 30 for some reason, can change them until March 31, 2017 by furnishing ID proof.
  • All coins/notes in lower denomination of Re1, Rs2, Rs5, Rs10, Rs20, Rs50 and Rs100 will continue to be valid.
  • The government will replace the old notes with new ones. The new notes of Rs500 and Rs2,000 would come in circulation mostly from March 31, 2017.
  • The government has also implemented a daily limit of Rs2,000 on ATM withdrawals, which will be increased to Rs4,000 at a later stage.
  • There are no changes in online, card, cheque or any other plastic money transactions.
  • Cash deposits above Rs.2.5 lakh threshold under the 50-day window could attract tax plus a 200% penalty in case of income mismatch

Key take away:

  • Ease of doing business- The move shows clear intent and determination of the Government to curb black money and promote a shift towards cashless economy. We view the measure as a big positive and a step forward in the reform process. It will be a significant image booster for India as reduction in corruption translates in ease of doing business.
  • Transitory pain in the offing – Abrupt slowdown in money circulation is expected to temporarily slow down the broader economic growth. Demand from industries and small self-owned businesses with heavy reliance on cash transactions is expected to take a hit.
  • Short term stress on rural economy likely- Transaction difficulties are expected to be more pronounced in the rural geographies due to poor access to banking services. Nearly 30% of rural household debt and 33% of rural credit is from the unorganized lending sources.
  • A huge structural positive in the long-term- GDP is expected to accelerate due to more inclusive growth,increased efficiency, higher tax collection and increase in public investments. Estimated USD 500-550 billion shadow economy can potentially get subsumed in the formal system, with almost USD 100 billion additional tax collection.

Key macroeconomic implications: We view the measure to be structurally positive for the Indian economy leading to a more inclusive growth. We believe that this move is likely to bring down corruption in the economy, increase tax collection, broaden tax compliance substantially, provide a boost to economic growth by amalgamating shadow economy with the formal economy and lead to a marked shift towards organized players.

a) Higher GDP growth as black economy is subsumed in the formal economy- The World Bank in July, 2010 estimated the size of the shadow economy for India at 23.2% in 2007. Various studies now point this number to be higher at 25% (i.e. USD 500-550 billion). A parallel shadow economy generates inflation and reduces revenue inflows for the Government, which could have been otherwise used for welfare and developmental activities. This clampdown on black money would lead to integration of these unaccounted for transactions in the mainstream economy leading to higher reported GDP number.

b) Higher tax-to-GDP ratio from proper reporting of income: Income tax collection is expected to see an uptick as funds earlier unaccounted for enter the banking system and eventually get taxed. On a USD 2 trillion economic base, total unaccounted tax is estimated to be USD90-100billion as against the actual tax collection of USD225-250billion in FY16.

c) Higher household savings in financial assets: Household sector saves either in the form of a) financial assets (40% of total household savings) including currency, net deposits with banks, investment in shares and debentures, life insurance funds, provident and pension funds or b) physical savings (60% of total household savings) including real estate, gold, etc. Historically, savings in physical assets has been higher compared to financial assets. However, with the attractiveness of other asset classes diminishing due to expected fall in asset prices, skew in savings mix is likely to correct favouring financial products.

Also, a huge upside can also be expected from the shift in unorganized money lending and informal investment schemes, such as Chit funds, to the formal system, thereby creating a robust demand for financial assets. We further believe that a higher proportion of savings in financial assets would get channelized through equity markets, including direct equity and mutual funds products, due to relatively higher return profile compared to other financial products.

Summary of macroeconomic impact

Macroeconomic Indicator Short term Impact (H2FY17)Long term impact (12 month and beyond)
GDPNegative – Consumption and investment demand to suffer due to cash crunchPositive – Rise in consumption due to efficient price discovery and higher investment in economy supported by the rise in tax collection to have a long term positive impact
Fiscal deficit/ tax collectionNeutral – Higher tax collection may come with a lagPositive – Better tax compliance and tax collection on nearly 25% of the unaccounted for funds to help improve fisc position
InvestmentsNegative – Short term working capital constraints and refinement of upcoming tendering process may cause some delaysPositive – Higher tax collection to provide flexibility for increasing investments in creating infrastructure
InflationPositive – To lower as downward pressure on prices persist due to lower demandNeutral – Unlikely to impact the long-term trend
Digital paymentPositive – Higher incentive to use digital payment platformsPositive – Larger population base to be brought on board the digital ecosystem

Sectoral implications: Sudden tightening of liquidity is likely to impact demand across many sectors in the near term. With 86% of the currency in circulation becoming unusable for commercial transactions we believe that the sectors with a higher incidence of cash transactions will suffer the most, including real estate, luxury items, jewelry, retailing, logistics, consumer durables, SME/rural lending, etc.

Thus, the widely anticipated demand upturn in the second half of FY17 on the back of good monsoon, pay bonanza for government employees and festive-season buying may see some disruption. Despite near term glitches in specific sectors, we expect significant long-term benefits to emanate from this move. We believe that across sectors a structural shift would be visible due to

a) Rising adoption of high end technology creating a robust digital financial ecosystem- we expect private sector banks to be the key beneficiary of this trend leading to higher fee based income and increase in savings deposits

b) Clear incentivization to shift from the unorganized to the organized platforms – Consumption oriented sectors like building materials, consumer durables and retailing would be the biggest beneficiary of the shift

c) Improvement in transparency leading to better governance standards. – this will have a far-reaching effect across all the sectors in the form of efficient price discovery, higher transactions through the formal system, etc.

Impact of this move on the performance of specific sectors and companies is analyzed below.

SectorImpactFactorsImpact on companies under coverage
Real estateNegativeNegatives


  • Project execution delays: Black component in real estate transaction would reduce impacting working capital availability with the builders


  • Lowering of demand: Micro markets with high investment demand to suffer the most in the medium term.


  • Price correction: Reduction in land cost and lowering of demand to put pressure on prices.


  • Shift towards organized players: Curb on cash transactions will impact unorganized players, creating a shift towards the organized segment


  • Efficient price discovery: Transparency in the system will lead to efficient price discovery for genuine buyers
Long term positive for organized players like Godrej Properties
BanksPositive Negatives


  • LAP portfolios to suffer: LTVs on LAP loans to rise making these assets riskier


  • Retail portfolio slowdown in short-term: Banks may have to relook underwriting processes for retail and rural financing for the next few months implying potential slowdown


  • Asset quality dip:a) Cash based EMI collection to be impacted leading to higher NPLsb) Rising risk on the LAP portfolio due to asset value contraction leading to high LTVc) Small business owners (SMEs/MSME) will find difficult to make payments on time


  • Liability profile to improve- CASA improvement as unaccounted cash finds way in the mainstream banking system


  • Higher fee income: Higher e-transactions, rising demand for credit and debit cards to result in higher fee income for the banks equipped with latest technology
Long term positive for IndusInd Bank and Axis Bank due to expected push on CASA and expected increase in fee-based income.
NBFCsNegative Negatives


  • Pressure on LAP portfolio: May slow down due to rising risks


  • Rural lending slowdown:  Lending to rural markets would be impacted as collection is mostly in cash


  • Asset quality dip:
    a) Cash based EMI collection to be impacted leading to higher NPLsb) LTVs on LAP loans to rise making these assets riskierc) Small business owners (SMEs/MSME) will find difficult to make payments on time


  • Demand pick up in CD financing: Cashless transaction will spur demand for CD financing options
Pressure expected in H2FY17 on the LAP, SME and rural portfolios of Capital First, Bajaj Finance, Edelweiss and L&T Finance but over 12-15 months this trend is expected to even out.
Housing FinanceNegative   Negatives


  • Loan growth to slow down: Anticipated project delays and overall price correction to impact loan book growth in the medium term. However, in the long term it is a positive for the HFCs due to rising eligibility limits and no cash component in transactions.


  • Current Portfolio: May not be impacted as most lending is to genuine home buyers
Negative for the loan book growth in the medium term for Repco and DHFL, asset quality however may remain intact.
CementNegative  Negatives


  • Indirect impact on demand: – 60-65% of consumption is by the real estate sector, therefore demand may be impacted due to expected slowdown in the real estate sector


  • Pricing pressure – Cement companies may cut down prices to tackle low demand, a rising cost scenario does not bode well for profitability of the sector.
Neutral impact on Ultratech as we expect demand contraction from housing to be compensated by the rise in infrastructure demand. Also, despite pricing pressure co. is expected to report better profitability supported by improving efficiency.
Building materialNegative Negatives


  • Demand slowdown: Demand for building materials such as tiles, sanitary ware, plywood, laminates, etc. would see an indirect impact due to lower demand from the real estate segment.


  • Pressure on receivables: Companies focused on tier-2 and 3 cities/towns, where a large part of the transaction is on cash basis, may face cash crunch in the short-term


  • Move towards organized segment: Sector to benefit from the shift towards organized players
Long term positive for building products players due to increasing shift in trade towards organized players including Cera Sanitayerware and Greenply.
RetailingShort term negative Negatives


  • Gold and jewelry- Demand for gold and jewelry is expected to drop as traditionally large unaccounted cash transactions are a common occurrence in this segment


  • Consumer Durables- Most consumption is B2C and ticket size is small prompting cash transactions (70-75% of current sales), temporary dip in volumes expected


  • Discretionary items– Demand for high-value luxury items may not be impacted as PAN disclosure is mandatory for Rs 2 lakh plus transactions, even currently.


  • Non-discretionary goods– Demand is sticky, therefore no long-lasting impact anticipated on these products


  • Move towards organized segment in jewelry – Curb on cash transactions will be a huge positive for the organized players.
Neutral for the luxury watch retailer, KDDL as plus Rs.2 lakh transactions already have a mandatory PAN disclosure requirement.


Long-term positives for the Consumer Durable plays, like Havells and Crompton Greaves Consumer electrical due to increasing shift towards organized segment.

We would like to conclude by saying that we highly commend the steps taken by the current Government to curb illegal trades and bring black money in the formal system. This move will strengthen India’s position as the most favored investment destination globally. Specifically, we expect equities as an asset class to benefit the most. Until now equities have competed with assets like real estate, gold and even chit funds, on an informal platform. Despite obvious benefits and consistent outperformance vis-à-vis other asset classes, equities till now has not found its rightful place as an investment product. We believe that the current move for demonetization has strengthened the case for equity investments.

1) Price correction in gold and real estate imminent – Value of gold and real estate is likely to correct as excess black money is sucked out and true price discovery on actual demand-supply basis emerges. This we believe will pull down the returns from these assets in the medium term.

2) Corporate performance to get a boost – Benefits of inclusive growth, efficiency gains, higher infrastructure spend, lower cost of capital, etc. is likely to provide additional growth triggers for corporate performance going forward, which should eventually get reflected in stock price appreciation as well.

3) Tax-advantage of investments in equities – Increased transparency in the system and disclosure norms will dissuade genuine investors from dabbling into other assets to save taxes, instead they would be incentivized to invest in equities that offers much higher tax free returns. (long term capital gains tax on equities is nil, whereas all other financial – PF, FD, Pension, etc.- as well as physical assets – real-estate, gold, etc.- are taxed on capital gains or on withdrawal)

In conclusion, we believe that markets are set for a strong recovery and hence recommend all our clients to readjust their portfolio weights in favour of equities. Choose quality names and invest for the long-term.


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