Demonetisation - The bigger picture

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Demonetization : The bigger picture

2. Demonetisation – The background
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• The growth in currency holdings with the public continued at a higher pace in the last 10 years. The last 2 years saw an alarming jump in the
numbers.
• Any unnatural increase in currency in circulation points to a leak in the banking system, as otherwise, cash would have got deposited with
the bank. If the money was in the banking system it has a multiplier effect in transforming into long term savings and investment of
individuals & companies while benefitting the Government in tax collections. Outside of banking system, its inflationary too.
• A significant portion of this unaccounted money in circulation which forms the black money, originates from undeclared income and it finds
its way to either Real estate, Gold or remains in the hands of people. Such asset classes are often seen as less productive too.
• Most importantly it is difficult to control by the Government making the managing of interest rates difficult.
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
20.00%
0
200000
400000
600000
800000
1000000
1200000
1400000
1600000
1800000
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Currency with public
Incremental growth Curreny with public

3. The Government’s action
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• The government has decided to replace the existing set of Rs 500 currency notes and completely abolish the Rs 1000
denomination. PM Modi announced that the RBI will introduce Rs 2,000 as a new denomination in India.
• The move is intended to fight corruption, black money and money laundering. In short, the idea is to bring the parallel economy
to a halt. And divert as much as possible to the banking system
• Currently Rs 17,54,000 crore worth of notes are in circulation according to the RBI’s database on the Indian economy. Of this
Rs.500 notes constituted almost 45% of the currency in circulation while 39% of the notes were of the Rs.1,000 denomination.
• This measure would mean, with immediate effect, almost 84% of the Indian currency is void.
• Let’s examine the implications even if 30% of it has been unaccounted for

4. Funds flow back..
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Legitimate money
Rs. 14.73 trillion
Approx. value of banned
notes in circulation
Small portion of this money
would be declared. Would
result in additional taxes
Most of this money comes
back in to the system as
bank deposits
Small portion would be
exchanged at banks
70% - Rs. 10.31
trillion**
30% - Rs. 4.42
trillion**
Illegitimate money
Increase in bank footfalls.
Massive boost to CASA
deposits and margin
expansion
Rural households open new
bank accounts to deposit
old notes. Massive boost to
financial inclusion
Most of the money is left
undeclared. Expires
worthless
Most of the Rs. 4.42 trillion
that expires worthless is a
direct gain to RBI. The same
can be paid back to govt. to
reduce fiscal deficit
Reduction in inflationary
pressure due to immediate
impact in purchasing power
*Please note that exact cashflows (Amount of legitimate and illegitimate money) would be determined post March 2017 once the window for depositing old notes closes.
** We have assumed 30% of the cash floating in the economy would be undeclared income

5. Benefits – Over various time frames
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Particulars Impact Reason
Fiscal deficit
This move could directly benefit the fiscal situation in the country. As mentioned before, the
unaccounted money is a direct benefit to the RBI and the same could be used by the Govt.
to reduce fiscal deficit or use it for several other development initiatives like infrastructure
spending
Interest rates
Increase in money supply in the system and reduction of fiscal deficit would lead to
reduction in interest rates. Immediate impact of the cash crunch would be a reduction in
consumption leading to drop in inflation, which creates more room for rate cuts. We believe
this move could lower interest rates by 1%-2% on a structural basis.
Taxation
There would be significant money coming in to the system and direct benefits to
government thereof. Going forward too, tax revenues of the government would also
increase. This would mean we can expect corporate taxes to come down to 25% sooner and a
possibility of reduction in individual taxes too.
Banking sector (Especially
PSU banks)
Tremendous long term benefits for banks as most of the legit money in cash will go back in to
the banking system.. PSU banks mainly benefit since they have a massive presence across
country. New bank Immediate positive impact with increase in footfalls in banks (especially
PSU banks) to deposit/Exchange cash accounts to be created. Surge in CASA levels will
improve deposit rates and help bring down lending rates and improve credit offtake.

6. Lets try and analyse short term impact
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Particulars Impact Reason
Real Estate
Almost 30% - 50% of real estate transaction value was done through cash and was used as a
means to park illegitimate cash. However the new rule of demonetization would lead to a
reduction in demand for real estate as hoards of cant be easily deployed. Property prices to
fall in coming months.
Gold
Just like real estate, a lot of black money is circulated while buying gold and other jewellery
items. The crackdown on the same is expected to lower the demand for gold in the short
term.
NBFC’s
Stocks of Non-banking finance companies, which largely carry out the transactions for the
small and medium enterprises, will also take a knock. SME borrowers (Especially smaller
ticket size) may see their cash flows getting impacted in the short term which may lead to
stress to NBFC cash-flows.
Discretionary
Consumption
In the coming months there would be an 84% currency void that would be created
immediately, but slowly filled over a period of time. This would mean, whatever cash the
consumer has, would be stored or channelized mainly for non discretionary expenses which
would mean a direct impact to discretionary consumption in the short term.
Liquor and Casino industry
Heavy amounts of dealing in these industry is in cash which would lead to reduction in
business in general for these sectors.

7. Final thoughts…
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This definitely could be termed as one of the boldest move of any government in the world to curb black
money significantly. With the current black money almost getting reset to zero, it’s a huge benefit to the Indian
economy. Another benefit would be that the counterfeit notes now would be significantly lower, as most of
them were in form of Rs.500 and Rs.1000 notes. These counterfeit notes were also used to fund terrorists
activities.
With almost 84% of cash vanishing from the system, and the sudden loss of purchasing power we may see the
economy slowing down a bit for sometime. We may even see our markets correcting (Markets deserved a
correction anyway, and this could trigger it) because of the reduction in consumption which was primarily
driving the earnings. This could further delay the earnings revival.
But, overall there would be huge structural benefits to the Indian economy in the long run. Once emerge
stronger out of this short term blip, we will have a more organized and efficient economy with less black
money. Most importantly, Indians` mind-set would have shifter towards honesty, financial savings & capital
markets away from corruption, excessive real estate (unproductive) and gold ( a big drain on our forex reserves)
In the future one may trace the roots of a structural bull market, to this NDA government`s move on
November 8th .

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