The stunning decision taken by the government to demonetise Rs. 500 and Rs. 1000 notes has astonished the nation.
This initiative may have long term benefits to the economy but at the same time, the ripple down effect of this expeditious move to tackle the menace of black money and corruption cannot be understated.
The market jitters created by the demonetization presents a value buying opportunity in equity market.
- Impact on Asset Classes
- Real Estate
The Real Estate would have a negative impact in medium and long term especially, the repurchase market. It is largely cash based and revaluation of current assets would possibly lead to losses.
- Gold and Jewellery Sector
Gold is considered to be the safe asset by many but Gold and Jewellery Sector is likely to face decline in price. Moreover, it is largely cash based, so this sector would face headwinds.
It is highly recommended not to invest in these tumbling asset classes.
In the long run, equity markets would benefit because:
- Organised sector would benefit as there would be less cash transactions. Unorganised sector would lose their business to organised sector.
- Lower inflation and interest rates would also benefit because the companies can borrow at lower cost and increase their profitability.
But in short term, the returns may remain volatile.
Here is a list of different sectors of the economy where government focus may fire up growth in these sectors:
- Public Expenditure
The total value of the defunct currency (Rs. 500 and Rs. 1000 notes) in India in circulation amounts to Rs. 14.2 trillion, which is about 86% of the total value of currency in circulation and the size of the shadow economy for India is pegged at 23.2% of GDP in 2007 (World Bank Report, 2010). The unaccounted value of currency amounts to Rs. 3.3 trillion.
Now, with the demonetisation move, total cash would have to flow through the formal banking system. Here, two possibilities would arise:
- The cash would be accounted by paying taxes and penalties or
- It would get extinguished.
The extinguishing of the major portion of the currency would reduce the liabilities of the government and with better tax compliances, tax to GDP ratio would improve leading to better tax collections.
With this, the government would get more money to spend. This would also mean that government may undertake large infrastructure projects and have multiplier effect on the economy. The GDP would increase by a multiple of initial increase in government expenditure.
- ‘Acche Din for Banks’
Now, the banking sector is expected to witness huge deposits as nobody would be willing to stash cash at home and this would lead to more lending, thus lowering of interest rates. There could be multiplier effect in the banking sector due to credit creation phenomena and ultimate increase in money supply due to an initial increase in checking deposits.
Financial Service Companies are expected to perform well in the coming months.
- Debt Market
Interest Rate cuts is good news for debt markets. With rate cuts, bond price would rise. Debt market would be bullish in the coming months.
- Informal Sector
Modi’s initiative may have permanently damaged the informal sector of India. It accounts for about 45% of the GDP. About 482 million people who earn cash incomes are likely to feel the heat. Disruption of liquidity may prove costly in terms of growth as it would affect consumption pattern for at least the next quarter.
On the other hand, Organised sector is likely to benefit from this reform.
Further GST would be significantly positive for the entire sector as it would kill the unorganised player in a big way. This would be positive for small players in organised space as large players anyway enjoy the premium.
Working Capital requirements for unorganised sector would increase as getting money from unscrupulous sources would be very difficult. Hence, they would lose out their business to organised players.
Tiles, Laminates, Cement and other Home Furnishing Companies may benefit in the long run. But in short term, these companies would face tough times.
- Consumer Durables and Non- Durables
Cash is the king of their business. They are likely to face problems. Discretionary spending would be impacted as the black money clampdown decision has eroded consumer’s real wealth. As a result, consumers may postpone their spending or would be very choosy on where to spend their money. The end consumer pays in cash to the dealers but dealers pay in cheque to the company. This move is going to be fantastic on long term basis.
FMCG companies may not face any lasting impact because of this decision.
- With rupee depreciation in short term, export oriented companies would be benefitted.
- India would be at competitive advantage as the exports would be cheaper and
- Export oriented companies would not face any cash crunch. These companies would perform well in near future.
But what would happen in short term is Deflation. Households would face liquidity constraints. Unorganised sectors who deal in cash would be volatile and impact the demand. There will be a negative GDP growth in the current quarter as the consumption pattern would get disrupted. .
When the earning cycle revives, earnings could grow far higher than the expectations.