On November 8, 2016, prime minister Narendra Modi made a speech which validated and cemented the current government’s commitment towards combating the scourge of black money in India. Looking at the reactions of the media, businesses, stock markets and the common man, it was a step that few thought possible, considering how soft past governments have been in tackling black money at a structural level.
Those calling this a surgical strike by the Modi government, seem to underestimate its potential. This is a WMD—a weapon of mass destruction—announced and, hopefully, executed with all the appropriate ‘shock and awe’ methods.
It is interesting to note that the prime minister, in his speech gave emphasis on the need for this move as it was critical in the fight against counterfeit banknotes and to curb the funding of terrorism. However, our research shows that its real target are the hoarders of black money. This is critical as the incestuous relationship shared by money launderers, tax evaders, terrorists, smugglers, drug runners, contraband sellers and other agents dealing in nefarious activities make any distinction or preferential treatment ineffective. The root of all these activities is black money
While this announcement is indeed significant, it follows a number of other steps which were aimed at cornering and identifying those who deal in black money. The setting up of the SIT, enhancements within the FIU, the black money Act, modifications in the Benami Transactions Act, encouraging various forms of cashless banking, the Income Declaration Scheme 2016, etc, are expected to have a multiplier effect. With Diwali having just gone, most families are expected to have already made significant purchases and investments for the year. Hence, this announcement seems well-timed.
We are seeing a number of interesting developments post this announcement, some of which happened within 15 minutes of the first news reports. Taxi aggregators sent out messages to their drivers to refuse 500- and 1,000-rupee currency notes. Large retail stores remained open till late night, taking advantage of the need to dispose off cash. Certain gold and foreign currency black-market dealers are selling at 100% mark-ups. This is only expected to increase. Tickets for rail travel, airlines and buses have seen a huge upsurge with some people buying tickets worth millions for future dates. While the Hawala market is in turmoil, extensive discounting has started taking place. These discounting rates are expected to increase daily, if not hourly. Wallets, payment gateways and fintech startups are seeing an upsurge in transactions and sign-ups of users and merchants. Real estate deals, especially in the secondary market, are expected to come to a temporary standstill.
It is our assessment that the long-term goal of this move is to increase the tax base from the current state, wherein less than 4% or only 29 million Indians file income tax returns out of which only half pay any income tax whatsoever. The aim is to clean up and recognise the owners of over 85% of the value of total cash in India (which is in 500- and 1,000-rupee notes). Apart from this, in terms of security, the government wants to replace these high-value denominations to nullify the years of counterfeiting of currency, which has been leveraged by terrorist organisations. This will also provide impetus towards cashless transactions and banking for all citizens. Dormancy rates of accounts is estimated to be 43% rendering Jan-Dhan Yojana largely ineffective. However, this de-monetisation will likely increase the activities in these accounts. This is expected to increase liquidity in the banking system, giving it a much required boost, especially with the current limited lending capacity of banks, due to higher provisioning requirements. Critical and positive impacts may also been seen in the short- to medium-term in the real estate sector and in inflation rates.
There are however certain negative effects, at least in the short-term for the common man. Farmers, who have recently received proceeds of kharif crops in cash, may have to depend on informal money-lending channels for rabi crop purchases
The ongoing marriage season may be adversely affected due to limited exchange and daily withdrawal limits, dampening the mood and bringing uncertainty to those who have hoarded cash for marriages.
Resale in the property markets are expected to face short-term issues, especially where the initial advance has been paid.
The service of cash-on-delivery by e-commerce companies is expected to take a definite hit as a result of non-availability of high denomination currency.
As unskilled labourers receive most of their payments in cash, sudden demonetisation has left many with little money for covering their expenses for the coming days.
The government of India has administered some much-needed tough love to the economy with this move thereby weaning us off the drug of black money. It would be wise to expect some intense withdrawal symptoms.
[With inputs from Abhishek Bali, senior vice-president (risk and advisory), BMR Advisors]
The author, Sarabjeet Singh is partner (risk and advisory), BMR Advisors, Views are personal