Nov 14, 2016
Economy & Strategy
Nov 14, 2016
Economy & Strategy
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Economy & Strategy
Demonetization Impact Report
India Research - Stock Broking
Small Short Term Pain for Large Long Term Gain
While everyone was bracing for the US presidential elections on Nov 08, 2016 evening, major news broke out in the form of the
Indian Prime Minister’s sensational decision of nullifying Rs. 500 and Rs. 1000 notes, to take the black money problem head on.
In independent India’s history, this is probably one of the most powerful economic decisions. It takes enormous guts to execute
it, and Prime Minister Narendra Modi has displayed that. While the decision is excellent, the real success of this monumental
decision lies in maintaining secrecy about it till the last moment. This move is clearly part of a broader well-calibrated agenda
of the battle against black money, and is a clear follow-up to voluntary IDS (Income Disclosure Scheme) launched by the
government. This move of nullifying Rs. 500 and Rs. 1000 notes makes it forceful income disclosure. The old Rs. 500 and
Rs. 1000 notes will have to be deposited / exchanged with banks, which naturally brings even unaccounted Rs. 500 and
Rs. 1000 notes into the regulator’s radar.
The Prime Minister clearly mentioned during his speech that there may be some inconvenience for about 15 days in the
execution of such a monumental decision. However, the long-term benets of this move will far exceed a little discomfort for
15 days. The global investors will surely upgrade their Indian investment outlook, as this move will elevate perceptions regarding
the transparency standards of the Indian economy.
We have seen truly game changing move from government regarding demonetization of Rs. 500 and Rs. 1000 notes. The move
has surely taken everyone by surprise, in terms of its sheer impact. Undoubtedly, this has become hot topic of discussion for
people across the economic spectra ranging from Cab Drivers to Corporate Directors.
While everyone is sensing the monumental nature of this decision, no one is in a position to make accurate quantitative
assessment of this move considering the fact there are only conjectures regarding size of black market in India. However,
sectors where there is higher component of Cash dealings such as Real Estate and Gold may have larger impact.
One unintended victim of this measure is unorganized players, who deal in cash (not necessarily unaccounted; but the regular
course of their client base). These unorganized players may also go through period of slowdown demanding the forceful alignment
of their business models accommodating online transactions and non-cash dealings. Investment cycle is also expected to
experience slow phase, as the re-adjustment process has to be completed adjusting to this new reality.
Macros and Taxes
By dierent studies, it is expected that the black money represents about one quarter of Indian GDP. The abrupt retraction of
such large size of the market overnight expects to trigger slowdown of GDP growth for coming two quarters, backed by slow
consumption and investment. However, this lost momentum in GDP growth can be expected to be recuperated post that two
quarter period, with renewed clarity on the new currency re-set.
Further, banks are expected to collect enormous amounts of CASA (Current Accounts, Savings Accounts) deposits during this
currency deposit / exchange program that should elevate liquidity levels in the system enormously. Since this program launched,
it is expected that Indian banking system has received deposits of about Rs.3 Lac Crores (~US$50 Bn). This can temper down
the bond yields substantially, and can trigger fresh interest rate cut by RBI in the upcoming monetary policy meeting.
With reduced interest rates, and with restoration of clarity, the investment cycle and GDP growth can come back strongly starting
the calendar year 2017, as some people symbolically refer to in “Hockey Stick” format.
As of FY15, the number of income tax assesses in India is about 52 Mn. With the current measures, there is an expectation that
the number of people expected to come in tax net to move up substantially. Further, the Tax-to-GDP ratio which is currently at
5.5% is also expected to improve.
Analyst Contacts
Jagannadham Thunuguntla
040 - 3321 6296
Nov 14, 2016
Economy & Strategy
Unaccounted Money
Those having unaccounted money will have to choose one of the following:
A. Do nothing with the unaccounted money
B. Deposit / Declare the unaccounted money
C. Adopt unocial routes to launder money
To put in simple words, let the old Rs. 500 and Rs.1000 notes
destroy / expire. In this case, the ramications are: the economy will
shrink to the extent money set to expire. However, the liability of the
government / RBI to that extent will get reduced, giving additional
leg room for government / RBI for infrastructure spending without
stoking ination.
Those who declare the unaccounted money may attract taxes and
penalties tantamount to 60-100% of the money, which can result
into huge wind-fall gain to Government in the form of one-time tax
collection. By some studies, the amount of money government
expected to attract in the form of taxes and penalties may equal one
full year’s scal decit.
Those who adopt unocial routes to launder money may risk
attracting huge penalties and prosecution. However, the laundered
money will come into ocial bank deposit routes, which may be long
term positive for the size of the economy.
Exhibit 1: Demonetization impact
Variable Immediate Impact Medium-Long term Impact
Liquidity Improve
Leads to increase in liquidity with banks, due
to increase in deposits.
Excess liquidity in the market to be normalized by the government / RBI.
Tax collection Improve
In the form of Taxes and Penalties, Government
may receive windfall one-time tax collection.
Neutral/ Improve
As income declarations increase, tax inow is likely to go up due to
increased base of tax net; and hence eventual increase in Tax-to-GDP ratio
from current levels of 5.5%.
Fiscal Decit Reduce
Increase in direct tax payments windfall to help
government to handle scal decit eectively.
As unaccounted funds enter the banking system, increase in tax inow to
be compensated through increased government spending.
GDP Reduce
Reduction in most cash based transactions is
likely to lead to slow-down in consumption and
investment trends.
Cash inux in the banking system is expected to boost the economy
through lending which in-turn is likely to improve consumer spending
and investment by businesses.
Simultaneously, direct taxes are expected to increase immediately
as the government is accepting tax in the form of old notes. This may
narrow the scal decit and improve government spending.
Export and imports could be neutral to this eect.
Therefore, total GDP is likely to improve.
10 year Govt
bond yields
Neutral / Reduce
There may not be any eect immediately.
However, with the increased liquidity
conditions in the system, 10-year bond yields
set to come down.
Depends on RBI/Government actions
If interest rate is decreased by RBI, then bond prices will increase
leading to decline in bond yields.
Source: Company, Karvy Research
Nov 14, 2016
Economy & Strategy
Exhibit 2: Impact of Demonetization on Sectors
Sector Impact of Demonetization
Auto & Ancillaries Consumer sentiment severely impacted across the country due to demonetization and near term liquidity
issue impacting the demand for all the consumption items like Passenger Vehicles (PVs), Two wheelers and
Commercial Vehicles (CVs) to some extent. We expect it would take at least 3-4 months for automobile industry
to come back to normal. This would have a chain reaction to auto ancillary companies over next 2 quarters,
particularly companies who have high dependence on domestic demand.
We expect two wheeler industry would be worst impacted, as 50% of the consumption of two wheelers is in
rural India, which has higher proportion of cash transactions compared to banking linked transactions. We also
expect sizable impact on Passenger Vehicles due to this issue, as ~35% of PV demand is through rural India.
We estimate short term impact on CVs, while with recovery in normal transaction, it would see early improvement,
as this category is purely need based sales and has lower sensitivity to consumer sentiments.
We expect limited impact on tractor sales due to healthy cropping this time, favourable monsoon and good
support nancing support from banking institutions.
We see 1-2 quarters’ impact on majority of the automobile and auto ancillary companies, except few ancillary
companies which have a global presence and higher revenue contribution from global clientele base.
However, in the long term, once the currency re-set is completed, the auto and auto ancillary industry is
expected to be improved.
BFSI Bank deposits are likely to increase signicantly on account of surge in deposits from people which would
widen the capital base of banks, primarily CASA (Current Account and Savings Account). This will reduce cost
of borrowing for banks and simultaneously reduces the cost of lending. However, there would be some short to
medium term headwinds on asset liability mix.
Now people with an outstanding liability in both parallel & unparallel form may face short to mid-term pressures
in terms of meeting the liabilities on time, which may further worsen NPA situation in the Indian banking system.
A closer look at the housing nance sector and loan against property, which are completely linked to the real
estate business, are likely to face signicant headwinds. Housing nance companies are likely to witness
considerable stress on loans given to real estate developers who may face liquidity crunch in short to medium
term. In the case of falling property prices, the existing Loan to value (LTV) ratio of banks/nance companies
would increase which may further increase the risk.
Demonetization move to propel cashless transactions, during FY15 paperless transactions (credit/debit/prepaid
cards, Electronic Fund Transfer, online mobile wallets) were Rs. 92 Lakh Crore. E-commerce (portals in India
registered retail sales worth of $5.30 billion in 2014) has helped rising paperless transactions. National Optical
Fibre Network (NOFN) project, that will connect 2.5 Lakh village panchayats with the internet, is expected to
further boost paperless transactions. Visas, MasterCard are expected to be the biggest beneciaries followed
by banks and online payment websites such as Paytm, Freecharge, MobiKwik etc.
Micronance segment may be impacted negatively in the short term as most of the transactions in the segment
are carried out in cash. However, things will return to normalcy once the re-set process is over.
Building Materials Now, the demonetization of the Rs.500 and Rs.1000 notes, expected to drastically impact the real estate sector,
which in turn would surely slow down the basic building materials business in the near to short term.
Building materials industry such as tiles, sanitary-ware, paints is completely dependent on real estate sector.
The cash crunch may make tough for them to deal with the working capital requirements in the near term.
The market share of the organized sector is about 60%, when the unaccounted money is curbed from the
society then the opportunities would improve for the organized players with narrowing of the price dierences.
For the medium term, where the realtors have huge unsold inventory have to sell their spaces, would surely
bring down the prices aordable for the buyers which in turn expected to help to pick up the building materials
sector in the long run.
Nov 14, 2016
Economy & Strategy
Sector Impact of Demonetization
Cement This will directly impact the cement o-take from both rural & urban housing markets as the considerable part
of transaction happens through cash during construction.
As the agricultural land prices are likely to correct, it will lead to slowdown in monetization of land. Thus, it is
expected to impact the construction activities like housing, irrigation (due to delay in accumulation of cash).
Cement dispatches are also expected to get impacted from logistics (as the transporters are raising issues
related to work stoppage by truck drivers due to non-payment).
Consumer Durables The cash sales in the consumer durables are expected to witness an impact for the near term till the new
currency comes into circulation. However, it is expected that the use of cards and cheques would compensate
for some purchases, but overall the move to replace the existing high-denomination notes is expected to hurt
sales in this segment in near term.
The demand for large consumer durables items such as apparels, white goods, apparel and the likes could also
witness near term impact.
However, this demonetization move may be long term positive for consumer durables with GDP set to improve
and eventually consumers will get consumer nancing at lower nance cost on the back of higher liquidity in
the system.
Infrastructure Overall pace of construction activities is likely to get impacted due to impending cash crunch with vendors and
raw material suppliers.
Contractors/developers are expected to see some delay in receivables.
Due to transportation hurdle, delay in construction activities is expected due to raw material availability issues.
Logistics Logistics industry is expected to see an adverse impact on short term, with the prices are likely to correct in the
short term with the reduced industry demand for movement of goods and also due to the cash component in
transactions would come down.
From clientele perspective, most of e-commerce clients of logistic companies deal in “Cash on Delivery”. By
various measures, the Cash of Delivery transactions can be expected to reduce by 25% due to this demonetization
move; and with their business getting hit of these developments, logistic companies performance is expected to
adversely impacted in short term.
However, once the things stabilize, logistics sector can be expect to improve.
Real Estate Property market is expected to see a big negative impact with the prices are likely to correct (as the cash
component in transactions would come down).
Agricultural land prices are also likely to get impacted as these also account for large amount of unaccounted
We rmly believe that this episode may have small short term pain which can constructively build large long term gain.
We believe:
The global investors will surely upgrade their Indian investment outlook from the medium to long term, as this move will
elevate perceptions regarding the transparency standards of the Indian economy.
GDP should revive back post two quarters of slowdown; and may knock on the door of double-digits due to enormous
accretion to the size of ocial economy.
CASA deposits and bank liquidity expected to substantially move up; which can oer enough leg room for RBI to reduce
interest rates.
Bond yields are expected to move lower; which can oer additional funds to corporate at lower interest rates.
Online and Digital economies are expected to grow substantially, as more people are expected to use these digital routes
for transactions.
Tax compliance perception is expected to improve, with increased number of tax assesses and improved level of Tax-to-GDP
The government is expected to gain rm control over scal decit with higher tax collections.
Digital and e-wallet companies will be the biggest beneciaries, as cash-less may become norm going forward.
Nov 14, 2016
Economy & Strategy
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