15 Impacts of Demonetization on Economy, Investment & Mutual Fund

15 Impacts of Demonetization on Economy, Investment & Mutual Fund

Roboadviso     Economy     Posted On, Sun 13th November, 2016     4 comments
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Demonetization Impact on mutual fund equity investment economy

The demonetization of Rs. 500 and Rs. 1000 bank notes, was a sudden and swift process that took the nation by surprise. In a move that has been lauded majorly by most of the sections of society, Prime Minister Narendra Modi on an unscheduled live TV address to the Nation on November 8, announced that the notes of Rs. 500 and Rs. 1000 would be deemed invalid as legal tender from the midnight of November 9, 2016.

The move has been an outcome of an extensive amount of confidential, research-backed work dating back to six months, as a part of a strategy to crack a whip on black money. The demonetization of the rupee can manifest in the form of varied set of repercussions on the economy.

Here are 15 ways in which devaluation of Rs. 500 and Rs. 100 can impact various markets: 

  • Effect in the Cash Economy – The currency of the aforementioned denominations constitutes around 87 percent of the total value of aggregate value of currency in circulation. Cash on hand comprise 3. 3 percent of household assets, higher than investments in Equities. Cash transactions also comprise a huge role in real estate, construction and informal, unorganized sectors like vegetable and fruit market. While the role of cash in real estate and gold is significant, it is also very crucial for the informal markets for their daily sustenance.  For instance, small and marginal farmers in vegetable and fruit market typically sell off their produce in the ‘local mandi’ in cash. Inaccessibility to ready cash equivalent to their produce can impact their earnings.  Of course, this is just a short-term inconvenience; things will ease out in the months to come.
  •  Rise in Tax Collection to GDP ratio – India’s tax to GDP ratio is 16.6 percent, according to Economy Survey 2015-16. This is lower than the average for emerging markets, which is around 21 percent.  With deposits going away from unproductive assets and getting channelized into banks post the demonetization of INR, the Tax to GDP ratio is set to rise.  The impact may not be very drastic, as people tend to pool vast amounts of money in property, gold, business inventory and receivables, anyway.  Also, when money in the new denominations become commonplace, people may continue to hoard the cash in their homes. So, for a short-time, one can expect a rise of about 1 to 2 percent, taking the Tax to GDP ratio to 18 or 19 percent.  Having said that, if more money gets accounted  for and more taxes are collected, the government may even be able to reduce tax rates.
  •  Lowering of GDP in short term – For a short period, the GDP is expected to go down due to reduced consumer demand stemming from compromised cash flow. The impact on construction, gold and informal sectors can lead to a dip in the GDP. However, the impact is not going to be significant, as the demand will only be deferred and revenue will enter these streams once the situation is normalized.  The short-term transitional impact can be outweighed by the long-term benefit for GDP growth, which has the potential to reach new heights.
  • Reduced Debt Yields – With an influx of money in banks, the demand for government bonds and other high rates bonds are expected to increase, leading to reduced bond yields. This can lead to price increase for old bonds and hence profit for Long Term Bond Funds & Tax Free Bonds
  • Cement and Steel to turn credit negative in the short-run The construction and real estate sector is strongly linked to sectors like steel and cement, which can turn credit negative for a short period. A measurable impact will be seen on daily and weekly wage earners in the informal and construction-related sector.  However, with more money coming into the banking domain, there will be a rise in deposits and subsequently, in the saving rate. So, on a medium to long-term basis, the benefits can surpass the short-term inconvenience.
  • Impetus to the Banking Sector – This comes as no surprise. With large amount of cash formalized into the banking stream, banks empowered by a high amount of current account and savings account (CASA) deposits, will have reduced dependence on high cost borrowing. It is estimated that India has a parallel economy with almost INR 4500 bill in the form of unaccounted cash.  So even, if some decent portion of this money comes to the banks, it can be boost the deposit base and savings, which may receive 0.5 to 1.5 percent of GDP according to estimates.  Banks are expected to curtail deposit rates by 25-50 basis points in the next six months.
  • Effect on Interest Rates – High Liquidity in Banking system will result in central bank cutting down Interest Rates.  Since banks are expected to generate huge deposits growth, the borrowing cost for Bank will come down and hence they will pass the benefit to consumers who take loan from bank by reducing Interest Rates. 
  • Shot in the arm for GST The demonetization strategy along with GST (Goods and Services Tax) can be quite counter productive in black money generation. The GST is a Value-Added Tax (VAT) which will be in effect from April 1, 2017. By virtue of GST, there will be a comprehensive indirect tax levied on manufacture, sale and consumption of good and services at the national level; this move will replace all indirect taxes on good and services levied by the central and state governments.  Along with GST, the demonetization can help in higher amount of tax to GDP ratio.
  • Boost to Jan Dhan accounts The Jan Dhan accounts have witnessed a remarkable growth in deposits, but even then the share of these accounts in the overall banking ambit has been under 1 percent.  Following the demonetization, the Jan Dhan accounts which have largely remained dormant, can be expected to record a surge in deposits.  The best thing to note is that demonetization move will inculcate banking habits among the vast populace, not yet familiar with the banking system. 
  • Second-hand auto markets to experience a drop Sales in the second-hand market for vehicle sales are expected to drop, which can also have a spiraling effect on OEM (Original Equipment Manufacturers) as buyers will not find it that simple to dispose their old vehicles.
  • Dip in the demand for big ticket purchases and high end retail products  For a short-term, consumer durable purchase in cash can be impacted due to a go-slow attitude towards discretionary spending.  Similarly purchases in cash for luxury and high end retail, will be impacted on a short-term.  Consumer sectors which involve non-discretionary purchases like QSRs (Quick Service Restaurants) may have low or moderate impact in the short-term, because even though they may deal mostly in cash, the target patrons can adapt to plastic money easily.
  • E-wallets set to rise The recently launched UPI (United Payments Interface) and e-wallet players like PayTM & Freecharge are going to benefit tremendously. Many of them have stepped up their marketing material with messages like ‘Cash is so yesterday’, driving India to ‘go cashless’.  App-based cab services like Ola are urging their customers  to go cashless and recharge using Ola Money.
  • Real Estate prices to go down  While there is not going to be much of an impact on the primary residential market, where houses are bought in the form of bank loans and mortgage; there is going to be a discernible impact in transactions which deal in cash.  Overall, the residential market may witness drop in prices, correcting to an average of 10 to 20 percent. Biggest impact of demonetization of money will be felt in tier 2 and tier 3 cities, where transactions have a high amount of cash component.
  • Mutual Funds to witness huge inflow – Demonetization will lead to increase of cashflow in Banking system. This liquidity is also expected to move to Mutual Fund as Investment. Mutual Funds are proven instrument to generate good tax efficient return in long term. This will benefit the mutual fund industry and investors as a whole.
  • Benefit to the Equity Markets – Equity market is expected to be volatile in short term because of uncertainty and slow down in economy. But in long term, GDP  and Corporate Earnings are expected to do well which will lead to higher growth in Equity market. Retail participation in stock market is expected to go up through Equity mutual Funds which will lead to increase in Equity Market. 

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